-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LMVbmq/X3QKJObsI43LI/umwQ8csX8TeyRf7YLth/aDSEV6o638qbonbuAB0Nmgc O2kwpr3d2f4IsZdCWyn7YQ== 0000950149-00-000109.txt : 20000203 0000950149-00-000109.hdr.sgml : 20000203 ACCESSION NUMBER: 0000950149-00-000109 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19991031 FILED AS OF DATE: 20000131 FILER: COMPANY DATA: COMPANY CONFORMED NAME: RENCO METALS INC CENTRAL INDEX KEY: 0000911566 STANDARD INDUSTRIAL CLASSIFICATION: PRIMARY SMELTING & REFINING OF NONFERROUS METALS [3330] IRS NUMBER: 133724916 STATE OF INCORPORATION: DE FISCAL YEAR END: 1031 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 033-68230 FILM NUMBER: 517025 BUSINESS ADDRESS: STREET 1: 238 NORTH 2200 WEST STREET 2: C/O MAGNESIUM CORP OF AMERICA CITY: SALT LAKE CITY STATE: UT ZIP: 84116 BUSINESS PHONE: 8015322043 MAIL ADDRESS: STREET 1: 238 N 2200 WEST CITY: SALT LAKE CITY STATE: UT ZIP: 84116 10-K405 1 RENCO METALS, INC. FORM 10-K 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended OCTOBER 31, 1999 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______ to _______ COMMISSION FILE NUMBER 333-4513 RENCO METALS, INC. (Exact name of registrant as specified in its charter) DELAWARE 13-3724916 (State or other jurisdiction (IRS Employer of incorporation or Identification No.) organization) 238 NORTH 2200 WEST SALT LAKE CITY, UTAH 84116 (Address of principal executive offices) (Zip Code) (801) 532-2043 Registrant's telephone number, including area code Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: NONE Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the proceeding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. [ ] YES [X] NO Indicate by check mark if disclosure of delinquent filers pursuant to ITEM 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Number of shares outstanding of each of the registrant's classes of common stock, as of January 27, 2000: COMMON STOCK, NO PAR VALUE: 1,000 SHARES. Aggregate market value of the voting stock held by non-affiliates of the registrant: $0; all shares of the voting stock of the registrant are owned by its parent, The Renco Group, Inc. Documents incorporated by reference: NONE - -------------------------------------------------------------------------------- 2 FORM 10-K RENCO METALS, INC. FISCAL YEAR ENDED OCTOBER 31, 1999 TABLE OF CONTENTS
PAGE NO. ---- PART I ITEM 1 - Business 3 ITEM 2 - Properties 9 ITEM 3 - Legal Proceedings 10 ITEM 4 - Submission of Matters to a Vote of Security Holders 12 PART II ITEM 5 - Market for Registrant's Common Equity and Related Stockholder Matters 13 ITEM 6 - Selected Financial Data 13 ITEM 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations 14 ITEM 8 - Financial Statements and Supplementary Data 17 ITEM 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 39 PART III ITEM 10 - Directors and Executive Officers of the Registrant 39 ITEM 11 - Executive Compensation 40 ITEM 12 - Security Ownership of Certain Beneficial Owners and Management 42 ITEM 13 - Certain Relationships and Related Transactions 42 PART IV ITEM 14 - Exhibits, Financial Statement Schedules, and Reports on Form 8-K 43 SIGNATURES 48
-2- 3 PART I ITEM 1. BUSINESS. Renco Metals, Inc. ("Renco Metals" or the "Company") is a holding company with two wholly-owned operating companies, Magnesium Corporation of America ("Magcorp") and Sabel Industries, Inc. ("Sabel"). Through Magcorp, the Company is engaged in the production and sale of magnesium and magnesium alloys for customers throughout the world. Sabel is a diversified company in the southeast United States primarily involved in the steel service center, scrap metal and rebar businesses. Magcorp and Sabel collectively are sometimes herein referred to as the "Subsidiaries" or "Guarantors." All of the Company's issued and outstanding capital stock is owned by The Renco Group, Inc. ("Group") which is owned by trusts established by Mr. Ira Leon Rennert, the Chairman and Chief Executive Officer of the Company and Group, for himself and members of his family. As a result of such ownership, Mr. Rennert controls the Company and its Subsidiaries. Group acquired Magcorp in 1989 and Sabel in 1987. Magcorp and Sabel became subsidiaries of Renco Metals upon its establishment. The Company was incorporated in Delaware in 1993, and its executive offices are located at c/o Magnesium Corporation of America, 238 North 2200 West, Salt Lake City, Utah 84116, (801) 532-2043. The Company classifies its operations into two operating segments: Magcorp's operations comprise the magnesium production segment, and Sabel's operations comprise the steel wholesaling and fabrication segment. Reference is hereby made to Note 13 to the Financial Statements, "Segment Information," included in ITEM 8, Part II of this Form 10-K. Unless otherwise indicated, references to a year are to the Company's fiscal year ended October 31. Neither Subsidiary's business is a) seasonal; b) requires unusual working capital; c) involves significant sales order backlog; or d) involves federal government contracting. Neither Subsidiary has foreign operations, and substantially all export sales are attributable to Magcorp. Reference is hereby made to Notes 2(i) and 14 to the Financial Statements, "Research and Development Costs," and "Significant Customers and Export Sales," included in ITEM 8, Part II of this Form 10-K. Substantially all research costs are attributable to Magcorp. MAGCORP Overview Magcorp is the second largest producer of pure magnesium and magnesium alloys outside the former Commonwealth of Independent States ("CIS") and People's Republic of China ("PRC"). The terms "CIS," "PRC," and "western world," which hereinafter refers to areas of the world excluding the CIS and PRC, are used by the magnesium industry's trade association, the International Magnesium Association ("IMA"), to delineate shipments and production of magnesium. Magcorp's Utah production facilities currently comprise approximately 18% of western world production capacity, according to IMA information and Magcorp management estimates. Magcorp participates in world magnesium markets that represented estimated demand of 366,000 metric tons in calendar year 1999, according to IMA information (based on nine-month statistical figures annualized), a 1.5% increase over the prior year. Competitive conditions changed significantly in 1999, most significantly with continued foreign import competition and the resultant market price decline. Description of Products, Markets, and Competitive Conditions The magnesium industry has relatively few participants and is highly competitive. Magcorp management estimates, from IMA and public information, that four major producers, Magcorp, Norsk Hydro AS ("Norsk Hydro"), Northwest Alloys, Inc. ("Northwest Alloys") and Dead Sea Magnesium, Ltd. ("Dead Sea Magnesium") together account for 87% of available western world production capacity. Magnesium imports from non-western world producers also continue to affect competition and are more fully discussed under "--Recent Industry Developments" below. -3- 4 Annualizing IMA nine-month statistical figures, calendar 1999 magnesium shipments can be estimated. The seven primary western world magnesium producers shipped an estimated 250,000 metric tons of magnesium in calendar year 1999. In addition, an estimated 116,000 metric tons of magnesium produced in the CIS and PRC were consumed in western world markets. The Company estimates that these combined shipments generated revenues of approximately $1.0 billion, based on 1999 average market prices. Calendar year 1999 shipments by western and non-western world producers represented a 3.8% decrease and 23.7% increase, respectively, over prior year levels, demonstrating the increased presence of non-western producers in the markets. Not all producers serve all end-user markets. Magcorp and Norsk Hydro market magnesium products to all the key end-user markets, whereas Northwest Alloys supplies an estimated 75% of its production capacity to its parent, Alcoa. Historically, Northwest Alloys has participated primarily in the aluminum alloying and desulfurization markets, but in 1999 has demonstrated some involvement in the die casting market. Norsk Hydro's Canadian plant (one of their two production facilities) has limited its participation in the U.S. market mainly to the die casting market, which utilizes magnesium alloys, in part due to the threat of high antidumping and countervailing duties on their pure magnesium imports to the U.S. See "ITEM 3. Legal Proceedings--Pending Trade Issues." Dead Sea Magnesium has publicized its commitment of one-third of their output to Volkswagen, and Magcorp management estimates that Dead Sea Magnesium currently produces a limited number of shapes and alloys. According to the IMA (based on nine month figures annualized), North American markets account for the majority of western world consumption of magnesium, 59% in calendar year 1999, whereas Western Europe and Asia account for 26% and 12%, respectively. All other western world areas combined account for the remaining 3%. North American consumption by end-use market is generally indicative of western world consumption as a whole. The following table compiled from IMA data presents magnesium consumption in North America, by customer category, with the end uses of each category for the past five calendar years: NORTH AMERICAN CONSUMPTION OF PRIMARY MAGNESIUM
CUSTOMER CATEGORY 1999(*) 1998 1997 1996 1995 END USES - ----------------- ------- ---- ---- ---- ---- -------- (in thousands of metric tons) Die Casting ............. 88.1 70.9 68.6 50.6 42.7 Automotive, electronics and hand tools. Aluminum Alloying ....... 81.5 81.1 72.8 66.0 77.6 Beverage cans, truck panels, home siding, aircraft and marine alloys. Desulfurization ......... 18.9 32.4 31.1 26.4 22.2 Steel production from iron. Electro-Chemical ........ 10.0 6.9 5.4 6.1 6.8 Cast anodes for cathodic protection of underground steel pipelines. Ductile Iron ............ 4.5 5.8 6.5 6.5 6.5 Pipe production, automotive components and heavy-earth moving equipment. Metal Reduction ......... 2.1 3.6 3.8 3.4 2.6 Production of titanium, zirconium, beryllium and uranium. Uses include aerospace, chemical processing and nuclear products. Others .................. 9.5 10.0 9.5 8.6 7.0 Sheet and plate and extrusion stock, gravity castings for aerospace applications, powder for flares, chemicals and exotic pharmaceuticals and perfumes. Total ............... 214.6 210.7 197.7 167.6 165.4 ===== ===== ===== ===== =====
(*) Based on 9 month IMA figures, annualized The key competitive issues in all end-use markets are pricing, long-term supply agreements with customers, assurance of a reliable supply, flexibility of deliveries, and shape, size and quality of product. As is evident in the North American consumption table above, consumption of magnesium has grown approximately 30% from calendar year 1995 to 1999, or at an average annual growth rate of 6% (although growth has not been uniform). This growth is due to magnesium's inherent metallurgical properties including its light weight, high strength-to-weight ratio, excellent corrosion resistance and reactivity with certain elements. These metallurgical properties have helped die casting to be the fastest growing segment of the domestic magnesium industry, where automobile manufacturers are turning to more magnesium parts to help lighten their vehicles. In calendar year 1999, combined consumption in all North American end use markets increased 1.9% over prior year levels. Overall growth in consumption in calendar 1999 was adversely affected by a sharp downturn in the desulfurization market, brought about by the US steel industry's slump, which is generally attributable to a surge in foreign steel import competition. Excluding the desulfurization market, overall consumption grew 9.8% in 1999. -4- 5 Potential Magnesium Supply The magnesium manufacturing process is highly technical and proprietary to each producer. Management estimates a cost of at least $500 million to establish a facility with the same production capacity as Magcorp's facility. It is reported that over $500 million has already been invested in the Dead Sea Magnesium plant, located in Israel, which began commercial production in 1998, and an additional investment of $100 million has been publicized as planned to increase capacity above the current level of 25,000 metric tons per year. Management estimates that North American producers, including Magcorp, operated at an overall level of about 85% of capacity for the first nine months of calendar year 1999. Numerous possible new magnesium plants have been publicized in 1999, including plants in Canada, Australia, Tasmania, the Congo, Netherlands and Iceland. Of these, the only plant currently under construction is Noranda, Inc.'s 63,000 metric ton annual capacity Magnola Project in Asbestos City, Quebec. The plant, which will use asbestos tailings as raw material feed stock, is estimated to cost $720 million (Canadian) and startup is scheduled for sometime in 2000. The Australian project in Queensland announced in 1997 is reportedly in an early pilot plant stage. Pending the outcome of the operation of the pilot plant, a 90,000 metric ton facility is being considered with initial manufacturing intended to come on-line in the 2002 to 2004 time range. Ford Motor Company ("Ford") has contributed financing for the Queensland pilot plant and has a long-term contract option for metal purchases. Norsk Hydro has not yet publicized any final approval of the 1997 announcement of their intent to increase production capacity at their Canadian plant by 43,000 metric tons in two phases. All other potential manufacturers have yet to complete feasibility and/or pilot or technical studies and the likelihood of their future existence is not known at this point. Recent Industry Developments Magnesium prices are sensitive to supply and demand conditions in all of the end user markets served by the magnesium industry. Magnesium generally sells for prices somewhat lower than the list price for pure magnesium, with price dependent on market segment, chemistry, contract terms, including negotiated discounts, and quality. No changes occurred in 1999 in North American list prices, but increased imports adversely affected the supply-demand balance and resulted in lower realized prices. Manufacturers in the PRC are significant exporters of magnesium. The Chinese Magnesium Association has indicated total annual capacity in the PRC is 200,000 metric tons. Magcorp believes that exports from the PRC to the western world may continue to increase; although there is also a belief that internal PRC consumption of domestically produced magnesium may increase. Furthermore, recent price trends for PRC magnesium may encourage the shutdown of some smaller, higher cost facilities in the PRC, some of which have already reportedly shut down due to low pricing. In 1999, limited amounts of PRC pure magnesium ingots were imported into the U.S. due to the antidumping duties in place. See "ITEM 3. Legal Proceedings--Pending Trade Issues." Duties also exist against imports of PRC pure magnesium into Europe. Alloy magnesium from the PRC is not subject to duties at the current time, and imports increased in 1999. PRC magnesium producers and magnesium grinders in other countries such as Canada grind imported PRC magnesium ingots into chips and powders that are not subject to the U.S. dumping duties. Imports of PRC magnesium powders are estimated to be about 20,000 metric tons in calendar 1999, an increase of 37% over the prior year, based on U.S. Department of Commerce ("DOC") statistics for eleven months annualized. PRC magnesium powder imports had a strong negative effect in 1999 on prices in the desulfurization market, where the powders are primarily used. Production in the CIS is believed to be relatively unchanged in 1999. However, 9% less CIS pure magnesium reached the U.S. in calendar year 1999 than in calendar year 1998, while alloy imports, primarily from Russian and Kazakhstan, increased by 110%. Calendar year 1999 imports of Russian pure and alloy magnesium were about 11,900 and 5,100 metric tons, respectively, based on DOC statistics for eleven months annualized. Some domestic users have entered into long-term arrangements to obtain Russian imports, as evidenced by General Motors and Ford entering into magnesium alloy supply agreements with Solikamsk Magnesium Works, one of the major Russian producers. Magcorp is continuing its efforts to maintain and increase the dumping duties against certain CIS and PRC imports, as well as limit circumvention of the duties, but there can be no assurance of success. See "ITEM 3. Legal Proceedings--Pending Trade Issues." -5- 6 As of September 30, 1999, the latest available date of IMA statistics, western world magnesium producer inventories on hand were 44,100 metric tons, as compared to 41,600 metric tons as of September 30, 1998. There is no public data available on PRC and CIS magnesium inventories on hand at producers, traders or consumers. Magnesium inventory levels, pricing and volume are dependent on the overall market supply and demand, and there is no certainty that current trends will not continue. Management expects continued strong growth in die casting, and with a continued increase in aluminum can usage and higher usage of rolled aluminum sheet in automobiles, it is likely that overall demand will continue to grow. Management estimates that western world magnesium producers will continue to operate at relatively high capacity utilization rates, but this is dependant on the overall supply and demand balance in the coming years. Customers and Products Magcorp sells pure magnesium and magnesium alloys to domestic and international customers in the key end-use markets, including the three largest - -- die casting, aluminum alloying, and desulfurization. Magcorp offers over 30 different sizes, shapes and weights of primary magnesium and magnesium alloy products in a range of purity levels to meet customer specifications. Magcorp's staff of three direct salespersons and four field representatives who receive technical assistance from plant personnel handles all established and prospective new domestic accounts. Accounts in Europe, Japan and Australia are handled through agency arrangements. Approximately 90% of Magcorp's annual sales volume is sold pursuant to contracts with select customers. During 1999, 1998 and 1997, sales to any single customer did not exceed 10% of total consolidated revenues. Reference is hereby made to Note 14 to the Financial Statements, "Significant Customers and Export Sales," included in ITEM 8, Part II of this Form 10-K. Raw Materials Magcorp's source of raw material for magnesium production is brine from the Great Salt Lake. The Great Salt Lake brine is concentrated through solar evaporation and selective precipitation of undesirable salts until a high grade magnesium chloride brine is produced for plant feedstock. The magnesium chloride brine is further purified, spray dried to powder using gas turbines, and melted to produce feed for electrolytic cells, which use direct electrical current to separate the magnesium metal and chlorine. The magnesium metal from the electrolytic cells is then refined and cast into the wide variety of pure magnesium and magnesium alloy products produced by Magcorp. Magcorp's natural gas requirements are purchased from gas producers or marketers, transported by a gas transportation company and delivered to the Rowley facility by a local gas distribution company. Management has negotiated favorable gas pricing due to the volume of Magcorp's requirements. Magcorp purchases its electrical requirements from a local utility pursuant to a contract in effect until January 1, 2002. As is the case with other industrial facilities, the terms of the contract grant the utility the right to interrupt electrical power to Magcorp under certain limited circumstances and with reasonable notice while providing Magcorp with advantageous electricity rates. Additionally, Magcorp is able to produce on average 25% of its electrical power needs through the gas turbines located at the Rowley facility. A variety of chloride-based by-products that are produced during the production of magnesium metal are sold into commercial markets or are neutralized and disposed of in compliance with environmental regulations. Magcorp has a 50 percent investment in KemMag LLC, ("KemMag"), a joint venture affiliate that sells ferrous chloride and ferric chloride to the waste water treatment industry. Aggregate sales of all by-products accounted for 2% or less of consolidated revenues in 1999, 1998 and 1997. Other raw materials critical to plant operations include graphite anodes, special refractory brick, and sulfuric acid. Magcorp maintains alternative sources of these raw materials to ensure a secure supply at competitive prices. Employees As of October 31, 1999, Magcorp had 503 employees, 152 of whom were salaried and 351 of whom were hourly workers. Approximately 84% of the hourly employees are represented by the United Steelworkers of America and employed under a four-year collective bargaining contract that expires August 31, 2001 and automatically renews for additional one-year periods (unless written notice of termination by either party is given). Magcorp believes that its relations with employees are satisfactory. -6- 7 Environmental Matters Title III of the Clean Air Act will establish, on a published schedule, new national emission standards for hazardous air pollutants (NESHAPS). NESHAPS are to be based on maximum achievable control technology as determined by a comparison of installations at similar facilities in specific industry categories. Representatives from the United States Environmental Protection Agency (EPA) have visited Magcorp's facility in preparation for the process of establishing NESHAPS for chlorine and hydrogen chloride emissions. It is expected that Magcorp will be required to make substantial reductions in chlorine emissions to meet NESHAPS for primary magnesium refineries that will be promulgated by November 2000, with an expected three to five year timetable for compliance following promulgation of the new standards. In anticipation of the new standards, Magcorp has embarked on a program to install new electrolytic cell technology that will reduce chlorine emissions at the source. The new cells are also expected to significantly reduce costs because they have much higher throughput and are more energy efficient. Cell conversion is expected to commence in late summer of 2000 and take place over approximately two years. With respect to hydrogen chloride, Magcorp has recently installed and is successfully operating scrubbers to reduce pertinent emissions. Magcorp does not expect that it will be required to spend significant additional amounts to meet the new standards for hydrogen chloride. Magcorp plans to spend an estimated $30 to $35 million of its capital expenditure budget for 2000 and 2001, directly or indirectly, to meet environmental regulatory requirements, primarily for NESHAPS, and for other anticipated future requirements. Prototype cell-related project development expenses to date total $6.5 million. There can be no assurance that Magcorp's cell conversion program will be successful, and to the extent it is not successful, it could have a material adverse effect on the Company's financial condition and results of operations. Representatives of the Utah State Department of Environmental Quality (UDEQ) Division of Solid and Hazardous Waste visited Magcorp in 1994 regarding the issue of whether piles of material generated in the electrolytic process, which cover an extensive land area at Magcorp's Rowley facility, can be classified as a hazardous or solid waste, and if so classified, what measures might be required to investigate and address these piles. No similar material has been classified by the State as hazardous or solid waste. The State accepted Magcorp's written storage plan, which does not consider the piles hazardous and under which no remediation or action by the Company is necessary. If the piles were at some point in the future to be classified as hazardous waste, thereby becoming subject to State regulation, corrective action could be required. The costs of such compliance, if any, could be material; however, such costs cannot be assessed at this time. Sampling conducted by Magcorp and by UDEQ in 1998 indicated a low but measurable accumulation of chlorinated hydrocarbons in the form of dioxin/furan compounds in soil and sediment samples from a contained and permitted process wastewater collection and retention system used at the Magcorp plant site for over 25 years. While Magcorp does not consider, and believes that UDEQ does not consider, a health hazard to be associated with these preliminary sampling results, Magcorp conducted additional sampling to determine the extent of accumulations of these compounds. Sampling results confirmed the accumulation of small amounts of dioxin/furan compounds in soil and sediment from the process wastewater collection and retention system, and that facility perimeter areas contained only background levels of the compounds. Management does not expect magnesium refineries to become subject to new regulations regarding these compounds in the near future. If these compounds do become subject to government regulation, the costs of such compliance, if any, could have a material adverse effect on the Company's financial condition and results of operations; however, such costs cannot be assessed at this time. Industrial companies such as Magcorp and Sabel have in recent years become subject to changing and increasingly demanding environmental standards imposed by governmental laws and regulations. The Company cannot currently assess the impact of more stringent standards on its results of operations or financial condition. SABEL Overview Sabel, founded in 1869, is a diversified company primarily involved in the steel service center, scrap metal and rebar fabrication businesses. Sabel's steel service center facilities distribute and process new carbon steel for large -7- 8 and small industrial accounts, as well as for the general public. Sabel's scrap metal operations process to customer specifications and sell and transport ferrous and non-ferrous scrap metal to mini- and integrated steel mills, foundries and other related metal companies. Sabel's rebar fabrication operation customizes rebar to shapes and sizes required for use in building and highway construction. Additionally, Sabel operates a full-service wholesale center that sells a variety of tools and plumbing, sprinkler, building and general supplies. Description of Products and Markets Served Steel Service Center. Sabel's steel service center division ("SSC") includes five facilities located in Montgomery, Dothan, Mobile and Tuscaloosa, Alabama and Newnan, Georgia. This geographic coverage allows Sabel to cost-effectively service most of Alabama, the Gulf Coast, the panhandle of Florida, Southern Mississippi, West Georgia and the Atlanta metropolitan area. In 1999, SSC accounted for 76% of Sabel's revenues. SSC specializes in stocking, reprocessing and delivering hot rolled and cold rolled carbon steel in a variety of sizes and shapes. Purchases of new steel for reprocessing are spread across approximately 15 steel mills including both integrated mills and mini-mills, thereby ensuring favorable prices and availability of product. SSC processes more than 60% of the steel it sells. SSC has an extensive list of approximately 3,000 customers ranging from large industrial companies to small welding shops. As a result, no single customer represents in excess of 5% of the division's total sales. The sales and marketing team at SSC consists of 16 direct salespeople and six sales representatives covering the Southeast region. All orders are entered and recorded through SSC's computerized system that facilitates order processing and delivery. Sabel continually works to improve the efficiency of this system to provide greater accuracy and speed in order entry. Scrap Metal. Management believes Sabel's 130 years of experience in the scrap metal business has fostered a strong reputation for quality and service. The scrap metal division of Sabel is a full-service scrap metal dealer with two large scrap yards located in Montgomery. Scrap metal in those yards is collected from approximately 250 suppliers, primarily industrial suppliers along with dealers and individual consumers. The scrap metal division sells to approximately 45 customers, including mini- and integrated steel mills, foundries and specialized manufacturing entities. As a freight-sensitive business, a majority of Sabel's scrap is sold to customers within its geographic area. In 1999, the scrap metal division accounted for 12% of Sabel's revenues. All scrap processed in the scrap metal division is inspected prior to shipment to ensure quality and compliance with customer specifications. As a result, management believes Sabel enjoys a high quality reputation and has an acceptance rate in excess of 99% for all scrap sold to customers. Rebar Fabrication Division. Sabel's rebar fabrication division ("RFD"), also located in Montgomery, purchases stock 60 foot bars from various rebar manufacturers and customizes the length, shape and bend according to construction blueprint plans. Structural bars and wire are widely used in the construction of buildings and highways. In 1999, RFD contributed 9% of Sabel's revenues. Since its formation, RFD has focused on construction projects from dams to driveways in its markets. Sabel's management believes RFD has established a strong track record for accuracy of shape and size and for prompt delivery due to the efficient design of the RFD facility. Orders for RFD's products are affected by the levels of activity in the construction and building sectors, as well as the conditions in the overall economy. Other Operations. Sabel also operates a wholesale center that sells a variety of tools and plumbing, sprinkler, building and general supplies. The wholesale center represented 3% of Sabel's 1999 revenues. Competition Each of the principal fields in which Sabel is engaged -- steel service centers, scrap metal and rebar fabrication -- is highly competitive. In each business field, Sabel competes with between five and eight other concerns, some of which are much larger. Sabel believes that no other company in its trading area offers the same range of services. In 1999 Sabel was unfavorably impacted by falling steel industry prices generally attributable to a surge in foreign steel import competition. -8- 9 Employees As of October 31, 1999, Sabel had 241 employees, 77 of whom were salaried and 164 of whom were hourly workers. Of the hourly employees, 55 are represented by the United Steelworkers of America. The current three year bargaining contract expires June 30, 2000. Sabel believes that its relations with employees are satisfactory. Environmental Matters The most significant long-term environmental issue at Sabel's facilities concerns compliance with storm water regulations under the Clean Water Act that became effective in 1991. Sabel is actively pursuing a program of compliance. Costs of compliance to date have not been material, and it is expected that costs associated with this program in the future will not have a material adverse effect on the Company's financial position or on results of operations. Environmental laws and regulations have changed rapidly in recent years, and Sabel may be subject to more stringent environmental laws and regulations in the future. Management cannot currently assess the impact of more stringent standards on the Company's results of operations or financial condition. ITEM 2. PROPERTIES. Magcorp Magcorp's main facilities include its headquarters located in Salt Lake City, Utah and its production plant located in Rowley, Utah, approximately 60 miles outside Salt Lake City. Magcorp's senior management, sales and marketing and administrative functions are based at the Salt Lake City headquarters. All production takes place at the Rowley facility. Inventory is stored at the Rowley facility and at a third party leased warehouse space in Utah, as well as locations throughout the world. Magcorp's production facilities are located on 4,525 acres of land immediately adjacent to the Great Salt Lake, which is the long-term raw material source. The brine from the Great Salt Lake is concentrated through one or both of two solar pond concentrating systems, the Stansbury Basin Pond System and the Knolls Pond System, to provide the final high grade brine feedstock for the magnesium plant. The Stansbury System is located about 15 miles and the Knolls System about 45 miles from the plant site. Both pond systems are capable of providing high-grade brine feedstock to the plant to facilitate nameplate plant production rates under normal operating conditions. Magcorp's production facility in Rowley, Utah was constructed in 1972, and has a current capacity rating of nearly 43,000 metric tons per year. The Company's operating permit with the State of Utah Department of Environmental Quality allows annual production of up to 43,545 metric tons. Magcorp owns the buildings and land comprising its Salt Lake City administrative offices and Rowley production facilities. The Knolls Pond System is located on land leased from the State of Utah for a term expiring on December 31, 2016 and on Federal land under a right-of-way from the Bureau of Land Management of the Department of Interior which expires in 2023. The Stansbury Pond System is located primarily on land leased from the State of Utah for a term expiring on March 8, 2010. Magcorp also holds other easements, rights-of-way and water rights primarily from the Bureau of Land Management and the State of Utah. Magcorp pays royalties to the State of Utah based on its production of magnesium from Great Salt Lake brine. The Rowley facility is readily accessible by truck and rail. Sabel Sabel's operations are carried out in nine facilities covering approximately 343,000 square feet across the Southeast region which include five steel service centers, two scrap metal yards, a rebar fabricating plant and a wholesale equipment supply center. Most of Sabel's facilities are leased from entities controlled by the Sabel family, from which Group acquired Sabel in 1987. The steel service centers are equipped to process steel from stock for their customers' needs and the rebar fabricating plant is equipped to fabricate bars to customer specifications. -9- 10 ITEM 3. LEGAL PROCEEDINGS. Pending Trade Issues Magnesium Imports from the Russian Federation, Ukraine and PRC In 1994, Magcorp filed an antidumping petition with the Department of Commerce ("DOC") and the U.S. International Trade Commission ("ITC") for imposition of antidumping duties against imports of magnesium from the Russian Federation, Ukraine and the PRC. In its petition, Magcorp alleged that imports of pure and alloy magnesium from producers in these countries were being sold in the United States at less than fair value and had injured the U.S. magnesium industry with resultant negative financial results, loss of markets, and layoffs of workers at U.S. magnesium producers. The antidumping duties sought in the petition generally exceeded 100%, reflecting the level of dumping and impact on domestic producers. In March 1995, the DOC determined that pure magnesium imports from all three countries were dumped in the United States, but also determined that certain Russian producers and traders were not dumping Russian magnesium products. In May 1995, the ITC announced its affirmative determinations that imports of pure magnesium from those three countries were a cause of injury to the domestic magnesium industry. The DOC and ITC decisions, taken together, resulted in the imposition of antidumping duties against imports of pure magnesium from each of the three countries at the following rates:
PURE Russian Federation ............ 0-100% Ukraine ....................... 80-104% PRC ........................... 108%
No antidumping duties were imposed against magnesium alloys. These rates are subject to revision in administrative reviews, which can be requested annually. Such reviews could have been requested in May 1996, 1997, 1998 and 1999, but none wer e. The next review request can be made in May 2000. In June 1995, one of the traders of Ukrainian magnesium appealed to the U.S. Court of International Trade ("CIT") the ITC's determination that imports of pure magnesium from Ukraine were a cause of injury to domestic magnesium producers. In August 1996, the CIT affirmed the ITC's determination. The Ukrainian trader appealed the CIT's decision to the U.S. Court of Appeals for the Federal Circuit ("CAFC"). In December 1997, the CAFC decided that the CIT applied an improper legal test and failed to consider certain evidence properly, vacated the CIT's decision and remanded the case to the CIT for further proceedings consistent with the CAFC decision. In April 1998, the CIT remanded the case to the ITC for reconsideration of its determination in light of the CAFC decision. In June 1998, the ITC issued a remand determination in which it decided that the domestic industry was not injured by reason of the imports of pure magnesium from Ukraine, and in October 1998, the CIT affirmed that remand determination. In December 1998, Magcorp appealed the decision of the CIT to the CAFC. Magcorp did not prevail in its appeal to the CAFC, and the 80-104% antidumping duties on imports of Ukrainian pure magnesium have been lifted. In June 1995, Magcorp appealed to the CIT the DOC's determination that certain producers and traders of Russian magnesium had not sold at less than fair value. In December 1996, the CIT affirmed the DOC's determination, with a required recalculation of the selling, general and administrative expenses. Magcorp appealed the CIT's decision to the CAFC. In January 1999, the CAFC affirmed the decision of the CIT. As a result, certain producers and traders of Russian magnesium will continue to be excluded from the scope of the antidumping order on pure magnesium from the Russian Federation. In November 1996, a PRC exporter requested a review of its U.S. export sales of pure magnesium on the basis that it is a new shipper of magnesium from the PRC. In January 1998, the DOC determined that the new shipper qualified for an antidumping duty rate of 69.53%. In February 1998 the PRC exporter appealed the DOC's determination to the CIT. In October 1999 the CIT denied the PRC exporter's appeal, leaving the DOC's determination intact. In December 1999, the PRC exporter notified the CIT that it wished to appeal the decision to the CAFC. Magcorp will appear in this appeal as a Defendant-Intervener in support of the DOC. -10- 11 Magnesium Imports from Canada In 1991, Magcorp filed a petition with the DOC and the ITC for imposition of countervailing and antidumping duties against Canadian and Norwegian magnesium producers. No duties were imposed on Norwegian imports. By November, 1993, final duty rates on magnesium imported into the United States from Canada (except magnesium from Timminco) were established by the DOC after appeals to panels established by the U.S.-Canada Free Trade Agreement as follows: Countervailing duties on pure and alloy magnesium imports ............ 7.6% Antidumping duties on pure magnesium imports ......................... 21.0%
Administrative reviews were initiated by the DOC regarding both the antidumping order and the countervailing duty ("CVD") orders. With respect to both the first and second antidumping review periods, which covered the period from February 20, 1992 through July 31, 1994, the DOC made final determinations that there had been no sales of pure magnesium by Norsk Hydro Canada Inc. ("NHCI" or "the Canadian producer") to the United States and, thus, no antidumping duty was collectable. With respect to the third through sixth review periods from August 1, 1994 through July 31, 1998, the DOC made a final determination that NHCI sales to the United States were made at prices that were not below fair value and, therefore, no antidumping duty was assessed on these imports and the antidumping duty deposit rate for imports from NHCI in the subsequent period was set at 0%. The seventh review, covering the August 1, 1998 through July 31, 1999 period, has been initiated. A respondent is permitted to request the revocation of an antidumping order after three years of findings by the DOC of no sales at less than fair value so long as the sales during each of those three years were made in commercial quantities. In connection with the fifth administrative review, NHCI requested that the antidumping order be revoked. Although the DOC found that NHCI sales to the United States were made at prices that were not below fair value during the third, fourth, and fifth review periods, the DOC determined that NHCI had not made sales in "commercial quantities" during any of these review periods, and, therefore, NHCI was not eligible for revocation. In the sixth review, the DOC again determined that the order would not be revoked because NHCI's sales in the fourth and fifth review periods were not in commercial quantities. The DOC did not make a determination as to whether sales during the sixth period of review had been made in commercial quantities. NHCI has appealed the DOC determination in the sixth review to the CIT. Magcorp has entered an appearance at the Court in support of the DOC's determination not to revoke the order in the sixth review. The DOC and the ITC have initiated five-year "sunset reviews" of both the antidumping order on pure magnesium from Canada and the countervailing duty orders on pure magnesium and alloy magnesium from Canada. In a sunset review, the DOC determines the level of dumping or subsidization that would be likely to occur absent the orders, and the ITC determines whether revocation of the orders would be likely to result in the continuation or recurrence of material injury to the domestic industry. The ITC has voted to conduct a full review in the sunset review investigations. The DOC has postponed its preliminary determination in its aspects of the sunset reviews. An elimination of the antidumping and countervailing duty orders as a result of adverse determinations by the DOC or ITC could have a material adverse impact on magnesium prices, depending upon market conditions. The DOC has finalized administrative reviews of the CVD orders on imports of pure and alloy magnesium from Canada for the first six review periods, as listed in the table below. The DOC has initiated the seventh CVD administrative review, which covers calendar 1998, and has scheduled the release of the final determination for that review for September 2000.
Description Period Rate ----------- ------ ---- Original Determination Calendar 1991 7.61% 1st Review 12/6/91-12/31/92 9.86% 2nd Review Calendar 1993 7.34% 3rd Review Calendar 1994 4.48% 4th Review Calendar 1995 3.18% 5th Review Calendar 1996 2.78% 6th Review Calendar 1997 2.02% 7th Review Calendar 1998 Initiated
-11- 12 Other Legal Proceedings In April 1998, the United States filed a complaint against Magcorp in the U.S. District Court for the District of Utah, alleging both statutory and common law claims. The United States alleges that Magcorp, in operating its Knolls Pond System, has taken magnesium out of mineral-laden ground water belonging to the United States without a mineral lease or payment of royalties. The United States makes these allegations even though prior to initiating its operations, Magcorp asked for, and received, assurance that the minerals were owned by the State of Utah. In a November 1998 disclosure statement requiring disclosure of computation of damages, filed in accordance with Federal Rule of Civil Procedure 26(1)(C), the United States claims that it has been damaged in the amount of $90 million. Management strongly believes this claim is based on the erroneous assumption that the magnesium produced from Knolls Pond brine came from groundwater belonging to the United States. The United States also claims that it is entitled to treble damages. Magcorp strongly disputes the United States' claims, and believes that the source of the minerals processed in the Knolls Pond System is the water pumped from the Great Salt Lake to the West Desert by the State of Utah - not groundwater - and that the Company properly purchased those minerals pursuant to an agreement with the State of Utah. In 1999 the United States added the State of Utah as a defendant and asserted that the minerals being harvested belong to the United States. The State of Utah filed its answer to the United States' allegations, and also denies the minerals being harvested belong to the United States. The United States has to date not produced any evidence to support its claims or its alleged damages. Magcorp believes that the United States' claims and its computation of damages are without merit and is vigorously defending against them. Magcorp believes it should prevail on its defenses to the United States' claims, and accordingly, believes that the ultimate outcome of this uncertainty will not result in a future loss that would be material to the Company's financial condition, results of operations or liquidity. If the United States were to prevail, it could have a material adverse effect on the financial condition or results of the Company, the extent of which are not estimable at this time. With the exception of the trade cases and claim discussed above, neither the Company nor its Subsidiaries is a party to any material legal proceeding other than ordinary routine litigation incidental to its business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted during the fourth quarter of fiscal year 1999 to a vote of security holders. On January 5, 2000, Group, as sole shareholder of the Company, executed a written consent, in lieu of meeting of shareholders, re-electing Mr. Rennert as Chairman of the Board and sole director of the Company. -12- 13 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. All of the Company's issued and outstanding common equity, 1,000 shares of common stock, no par value, are owned by a single stockholder, Group. There is no established public trading market for these shares. The Company paid to Group dividends totaling $7.2 million in 1998 and $6.6 million in 1997. No dividends were paid in 1999. The payment of and amounts of dividends are restricted by the Company's long-term debt agreements, which generally allow dividends of up to 50% of consolidated net income. Based on profitability and after taking into account the Company's prospects and liquidity needs, the Company plans to pay quarterly dividends to the extent allowed by the Company's long-term debt agreements. As of October 31, 1999, $2.7 million was available for dividends under the terms of the Company's long-term debt agreements. ITEM 6. SELECTED FINANCIAL DATA. The following table sets forth selected financial and operating data relating to the consolidated results of the Company as of and for each of the years in the five-year period ended October 31, 1999. Such selected information is qualified by and should be read in conjunction with the detailed information and consolidated financial statements and the notes thereto appearing elsewhere herein.
Year ended October 31, ------------------------------------------------------------------- 1999 1998 1997 1996 1995 --------- --------- --------- --------- --------- STATEMENT OF OPERATIONS DATA: (in thousands) Net sales $ 179,613 $ 189,699 $ 191,614 $ 196,974 $ 185,806 Cost of sales 127,694 125,823 129,093 116,808 121,189 Depreciation, depletion, and amortization 9,131 8,289 7,451 6,509 5,770 Selling, general, and administrative expenses 21,774 23,131 20,848 22,704 18,470 Operating income 21,014 32,456 34,222 50,953 40,377 Interest income 576 1,163 1,142 1,353 881 Interest expense 18,618 18,871 18,697 13,045 10,138 Income tax expense (benefit) (1,963) 4,342 4,963 13,534 11,143 Income from continuing operations 5,318 10,455 11,768 25,727 19,977 Extraordinary item - - - (7,284) - Net income 5,318 10,455 11,768 18,443 19,977
October 31, --------------------------------------------------------------------- 1999 1998 1997 1996 1995 --------- --------- --------- --------- --------- BALANCE SHEET DATA: (in thousands) Working capital $ 59,221 $ 63,174 $ 54,079 $ 47,677 $ 58,880 Property, plant, and equipment, net 41,862 35,385 37,715 36,613 32,014 Total assets 126,091 126,649 126,387 118,658 116,551 Total debt 153,229 154,977 155,183 154,150 78,012 Stockholder's equity (deficit) (60,193) (65,611) (68,866) (74,034) 4,760
-13- 14 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The Company is a holding company incorporated on July 19, 1993 that has two wholly-owned operating companies, Magcorp and Sabel. Through Magcorp, the Company is engaged in the production and sale of magnesium and magnesium alloys for customers throughout the world. Group acquired Magcorp in August 1989. Sabel is a diversified company in the Southeast United States primarily involved in the steel service center, scrap metal and rebar businesses. Sabel was acquired by Group in July 1987. The following discussion and analysis should be read in conjunction with the consolidated financial statements and the notes thereto and other financial information included elsewhere herein. Unless otherwise indicated, references to a year are to the Company's fiscal year ended October 31. RESULTS OF OPERATIONS
Year ended October 31, ------------------------------------------------- 1999 1998 1997 --------- --------- --------- (in thousands) Sales by operating segment: Magcorp $ 134,728 $ 141,333 $ 147,113 Sabel 44,885 48,366 44,501 --------- --------- --------- Total sales 179,613 189,699 191,614 Cost of sales 127,694 125,823 129,093 Depreciation, depletion, and amortization 9,131 8,289 7,451 Selling, general, and administrative expenses 21,774 23,131 20,848 --------- --------- --------- Total operating income 21,014 32,456 34,222 Interest income 576 1,163 1,142 Interest expense (18,618) (18,871) (18,697) Equity in earnings of affiliate 383 49 64 --------- --------- --------- Earnings before income taxes 3,355 14,797 16,731 Income tax expense (benefit) (1,963) 4,342 4,963 --------- --------- --------- Net income $ 5,318 $ 10,455 $ 11,768 ========= ========= =========
1999 COMPARED TO 1998 Sales for 1999 decreased 5.3% over 1998. The decrease was attributable to a 4.7% decrease in Magcorp's revenues and a 7.2% decrease in Sabel's revenues. Magcorp's average selling price for magnesium decreased 5.0% while magnesium shipments remained constant. Import competition from foreign producers continues to put pressure on magnesium pricing and volumes, particularly in the steel desulfurization segment of the magnesium business. Magnesium pricing and volume are dependent on overall market supply and demand, and there is no certainty that current trends will not continue. Sabel's sales decrease was due to overall price and volume decreases affecting the U.S. steel industry. Cost of sales for 1999 increased 1.5% on a consolidated basis. Magcorp's cost of sales increased 6.6% due in large part to increased processing costs associated with increased volumes of recycled magnesium when compared to the corresponding period in 1998. Magcorp continues to increase its participation in die cast markets, which also requires handling and recycling of die cast customer scrap, increasing costs and decreasing margins. The 12.5% cost of sales decrease at Sabel is attributable to the volume and price decreases mentioned above. Depreciation, depletion and amortization for 1999 increased 10.2% from 1998 primarily due to increased depreciation of property, plant and equipment as a result of recent capital equipment additions. -14- 15 Selling, general and administrative expenses for 1999 decreased 5.9% primarily due to decreased computer consulting costs, development costs, legal costs, and profit-based compensation accruals when compared to the corresponding period in 1998. Interest income decreased $587,000 due to cash and cash equivalent balances on hand that decreased to a month-end average of $14.8 million in 1999 from a month-end average of $25.7 million in 1998. Interest expense for 1999 decreased $253,000 due to lower long-term debt levels than in the corresponding prior period. Equity in earnings of affiliate reflects undistributed equity in earnings of Magcorp's investment in KemMag, a joint venture more fully described in Note 6 to the consolidated financial statements in ITEM 8. Income taxes reflects the Company's change in taxable status effective November 1, 1998 described in Note 2(g) to the consolidated financial statements in ITEM 8. Accordingly, the Company recognized an income tax benefit of $2.0 million that includes the elimination of net deferred tax liabilities recorded as of October 31, 1998. 1998 COMPARED TO 1997 Sales for 1998 decreased 1.0% over 1997. The decrease was attributable to a 3.9% decrease in Magcorp's revenues, which was offset by an 8.7% increase in Sabel's revenues. Magcorp's average selling price for magnesium decreased 1.8% and magnesium shipments decreased 3.5%. Foreign import competition put pressure on magnesium volumes and pricing in 1998, particularly in the steel desulfurization segment of the magnesium business. Magnesium pricing and volume are dependent on overall market supply and demand, and there is no certainty that current trends will not continue. Sabel's sales increase was primarily due to the opening of a new steel service center in Newnan, Georgia in November 1997, offset by decreases in steel industry pricing in general. Sabel sales volume and prices were adversely affected by imports during the final quarter. Cost of sales for 1998 decreased 2.5% from 1997 on a consolidated basis. Magcorp's cost of sales decreased 6.2% due primarily to decreases in acquired energy costs when compared to the corresponding period in 1997. Unit costs of electricity decreased 32% over 1997 levels, reflects an amended utility contract that became effective January 1998. Magcorp's cost of sales is highly sensitive to acquired energy costs and levels of production. The cost of sales at Sabel increased 9.4%, which is primarily due to the opening of a new steel service center in Newnan, Georgia in November 1997. Depreciation, depletion and amortization for 1998 increased 11.2% from 1997 primarily due to increased depreciation of property, plant and equipment as a result of recent capital equipment additions. Selling, general and administrative expenses for 1998 increased 11.0% from 1997 due to in large part to increased costs associated with the new steel service center at Sabel and increased development costs and computer software consulting costs at Magcorp. Development costs increased 14.8% in 1998 due to magnesium process enhancement piloting at Magcorp. Interest income for 1998 increased $21,000 from 1997 due to cash and cash equivalent balances on hand that increased to a month-end average of $25.7 million in the current period from a month-end average of $23.5 million in the corresponding prior period. Interest expense for 1998 increased $174,000 due primarily to higher revolving credit borrowings at Sabel in 1998. This increase was offset by a decrease in interest expense attributable to the redemption on July 15, 1998 of the remaining $1.5 million of 12% Senior Notes due 2000. Income taxes are estimated at statutory rates, including estimates of available credits, for both years presented. LIQUIDITY AND CAPITAL RESOURCES The Company's liquidity needs arise from working capital requirements, capital investments and interest payment obligations. The Company's primary source of liquidity has historically been cash provided by operating activities. The Company also has available $40.0 million in revolving credit facilities that provide for advances by the lender based on specified percentages of eligible accounts receivable and inventories to a maximum of -15- 16 $33.0 million for Magcorp and $7.0 million for Sabel, net of outstanding letters of credit. As of October 31, 1999, the unused amounts available to Magcorp and Sabel were approximately $29.7 million and $4.2 million, respectively. During the year ended October 31, 1999, Sabel repaid a net amount of $1.7 million under its revolving credit facility. With planned capital expenditures and declining margins, both discussed below, Magcorp anticipates it will utilize its revolving credit facility beginning in 2000. Cash provided by operating activities was $4.1 million for the year ended October 31, 1999 compared to $8.6 million provided by operations for the corresponding prior period. The $4.5 million decrease in cash provided by operations resulted primarily from decreased operating income. Magcorp is increasing inventory levels to accommodate decreases in production that are planned to take place during the period of conversion to new electrolytic cell technology discussed below. The increase in inventories is also due to increased volumes on hand of recycled die cast magnesium to be processed by third parties or already processed by third parties. The reduced operating income is attributable to lower sales volume and pricing from increased import competition in both the magnesium and steel operations and by lower margins on increased sales of die cast market products. Pricing and volume are dependent on the overall market supply and demand, and there is no assurance that current trends will not continue. Capital expenditures were $15.7 million for the year ended October 31, 1999, of which approximately $7.3 million is related to the new magnesium direct-chill caster. The new caster was put into service in September 1999 and is expected to improve product quality, reduce labor requirements and permit Magcorp to produce certain customer-specified sizes, shapes and weights of magnesium ingots at lower cost. Capital expenditures are budgeted at approximately $23 million for 2000, $13 million for 2001, and $3 million for 2002. Of these projected capital expenditure amounts, an estimated total of $31 million is related to new electrolytic cell technology that is expected to improve manufacturing efficiencies and ensure compliance with future environmental standards. Original plans for complete plant conversion have been scaled back to allow some flexibility due to reduced cash flow from operations caused by worsened market conditions. Prototype work is essentially complete on the new electrolytic cells, and certain long acquisition lead-time components have been designed and/or ordered. Conversion of the cells is expected to commence in late summer of 2000 and take place over a period of approximately two years. Associated cost reductions and related manufacturing efficiencies will occur gradually as conversion progresses, but will not be fully realized in the Company's operating results until 2002. Management anticipates that existing cash balances and cash generated from operations and availability under its revolving credit facilities will be sufficient to finance the Company's liquidity needs for the foreseeable future. However, if magnesium market conditions further deteriorate, in order to fund its planned capital expenditures through 2001, the Company may need to consider additional sources of liquidity or further scale back Magcorp's cell conversion project. The Company's long-term debt agreements contain numerous covenants and prohibitions that limit the financial activities of the Company, including requirements that the Company satisfy certain financial ratios and limitations on additional indebtedness. The ability of the Company to meet its debt service requirements and to comply with such covenants will be dependent upon future operating performance and financial results of the Company, which will be subject to financial, economic, political, competitive and other factors affecting the Company, many of which are beyond its control. YEAR 2000 READINESS We have not experienced any operational problems as a result of Year 2000 issues. Replacements of mainframe-based information technology systems began in 1994 and were planned with Year 2000 compliance in mind. Since 1994, the Company has expensed approximately $1.1 million in information technology and process control maintenance or modification costs and capitalized approximately $700,000. No additional Year 2000 costs are anticipated. -16- 17 ENVIRONMENTAL MATTERS The Company and its operations are subject to an increasing number of federal, state and local environmental laws and regulations governing, among other things, air emissions, waste water discharge and solid and hazardous waste disposal. Environmental laws and regulations continue to change rapidly and it is likely that the Company will be subject to increasingly stringent environmental standards. Compliance with such laws and regulations is a significant factor in the Company's operations as it is with all domestic industrial facilities. The Company believes that it has to date materially complied with all federal, state and local environmental regulations and is committed to maintaining its compliance with these laws. See "ITEM 1. Business--Environmental Matters." FORWARD-LOOKING STATEMENTS This report includes "forward-looking statements," which involve known and unknown risks, uncertainties and other important factors that could cause the actual results, performance or achievements of the Company to differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. Such risks, uncertainties and other important factors include, among others: general economic and business conditions; industry capacity; demand; industry trends; competition; currency fluctuations; the loss of any significant customers; availability of qualified personnel; changes in environmental regulations; successful completion of planned installation of new technology; major equipment failures, import and customs regulations, and outcome of litigation. These forward-looking statements speak only as of the date of this report. The Company expressly disclaims any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement contained herein to reflect any change in the Company's expectations with regard thereto or any change in events, conditions or circumstances on which any such forward-looking statement is based. ITEM 8. FINANCIAL STATEMENTS. Financial statements follow immediately and are listed in ITEM 14 of Part IV of this report. -17- 18 INDEPENDENT AUDITORS' REPORT The Board of Directors and Shareholder Renco Metals, Inc. and Subsidiaries: We have audited the accompanying consolidated balance sheets of Renco Metals, Inc. and subsidiaries as of October 31, 1999 and 1998, and the related consolidated statements of income, stockholder's deficit, and cash flows for each of the years in the three-year period ended October 31, 1999. In conjunction with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Renco Metals, Inc. and subsidiaries as of October 31, 1999 and 1998, and the results of their operations and their cash flows for each of the years in the three-year period ended October 31, 1999, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. KPMG LLP Salt Lake City, Utah December 3, 1999 -18- 19 RENCO METALS, INC. AND SUBSIDIARIES Consolidated Balance Sheets October 31, 1999 and 1998 (Dollars in thousands, except per share amounts)
ASSETS 1999 1998 --------- --------- Current assets: Cash and cash equivalents $ 8,448 21,690 Accounts receivable, less allowance for doubtful accounts of $532 in 1999 and $514 in 1998 25,478 26,411 Inventories, net 44,979 36,525 Prepaid expenses and other current assets 1,678 999 --------- --------- Total current assets 80,583 85,625 Property, plant, and equipment, net 41,862 35,385 Other assets, net 3,646 5,639 --------- --------- $ 126,091 126,649 ========= ========= LIABILITIES AND STOCKHOLDER'S DEFICIT Current liabilities: Current installments of long-term debt $ 25 23 Accounts payable 7,043 7,279 Accrued expenses 14,294 15,052 Deferred income taxes -- 97 --------- --------- Total current liabilities 21,362 22,451 Long-term debt, excluding current installments 153,204 154,954 Postretirement medical benefits 6,779 6,773 Deferred income taxes -- 1,966 Other liabilities 4,939 6,116 --------- --------- Total liabilities 186,284 192,260 --------- --------- Stockholder's deficit: Common stock, no par value. Authorized, issued, and outstanding 1,000 shares 1 1 Additional paid-in capital 600 500 Accumulated deficit (60,794) (66,112) --------- --------- Net stockholder's deficit (60,193) (65,611) Commitments and contingencies --------- --------- $ 126,091 126,649 ========= =========
See accompanying notes to consolidated financial statements. -19- 20 RENCO METALS, INC. AND SUBSIDIARIES Consolidated Statements of Income Years ended October 31, 1999, 1998, and 1997 (Dollars in thousands, except per share amounts)
1999 1998 1997 --------- --------- --------- Sales $ 179,613 189,699 191,614 Costs and expenses: Cost of sales 127,694 125,823 129,093 Depreciation, depletion, and amortization 9,131 8,289 7,451 Selling, general, and administrative expenses 21,774 23,131 20,848 --------- --------- --------- Income from operations 21,014 32,456 34,222 Interest income 576 1,163 1,142 Interest expense (18,618) (18,871) (18,697) Equity in earnings of affiliate 383 49 64 --------- --------- --------- Income before income taxes 3,355 14,797 16,731 Income tax expense (benefit) (1,963) 4,342 4,963 --------- --------- --------- Net income $ 5,318 10,455 11,768 ========= ========= =========
See accompanying notes to consolidated financial statements. -20- 21 RENCO METALS, INC. AND SUBSIDIARIES Consolidated Statements of Stockholder's Deficit Years ended October 31, 1999, 1998, and 1997 (Dollars in thousands)
NET ADDITIONAL ACCUM- STOCK- COMMON PAID-IN ULATED HOLDER'S STOCK CAPITAL DEFICIT DEFICIT ------- ------- ------- ------- Balances at October 31, 1996 $ 1 500 (74,535) (74,034) Dividends -- -- (6,600) (6,600) Net income -- -- 11,768 11,768 ------- ------- ------- ------- Balances at October 31, 1997 1 500 (69,367) (68,866) Dividends -- -- (7,200) (7,200) Net income -- -- 10,455 10,455 ------- ------- ------- ------- Balances at October 31, 1998 1 500 (66,112) (65,611) Capital contribution -- 100 -- 100 Net income -- -- 5,318 5,318 ------- ------- ------- ------- Balances at October 31, 1999 $ 1 600 (60,794) (60,193) ======= ======= ======= =======
See accompanying notes to consolidated financial statements. -21- 22 RENCO METALS, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Years ended October 31, 1999, 1998, and 1997 (Dollars in thousands)
1999 1998 1997 -------- -------- -------- Cash flows from operating activities: Net income $ 5,318 10,455 11,768 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, depletion, and amortization 9,131 8,289 7,451 Amortization of financing fees 980 989 989 Loss (gain) on disposal of equipment (30) 43 29 Deferred income taxes (2,063) (175) (187) Provision for bad debts 180 37 163 Postretirement and deferred compensation plans 245 118 476 Other (283) 11 (64) Decrease (increase) in operating assets: Accounts receivable 753 1,463 (3,065) Inventories (8,454) (9,532) 224 Prepaid expenses and other assets (699) (45) 1,410 Increase (decrease) in operating liabilities: Accounts payable (236) (983) 468 Accrued expenses (758) (4,399) (35) Other liabilities 50 2,280 350 -------- -------- -------- Net cash provided by operating activities 4,134 8,551 19,977 -------- -------- -------- Cash flows from investing activities: Capital expenditures (15,671) (6,014) (8,604) Proceeds from sale of equipment 93 12 22 -------- -------- -------- Net cash used in investing activities (15,578) (6,002) (8,582) -------- -------- -------- Cash flows from financing activities: Net borrowings (repayments) under revolving credit agreements (1,725) 1,311 1,052 Repayment of long-term debt (23) (1,517) (19) Financing fees and tender offer premiums paid (50) (60) -- Dividends to Group -- (7,200) (6,600) -------- -------- -------- Net cash used in financing activities (1,798) (7,466) (5,567) -------- -------- -------- Increase (decrease) in cash and cash equivalents (13,242) (4,917) 5,828 Cash and cash equivalents, beginning of year 21,690 26,607 20,779 -------- -------- -------- Cash and cash equivalents, end of year $ 8,448 21,690 26,607 ======== ======== ======== Supplemental disclosures of cash flow information: Cash paid during the year for interest $ 17,638 17,934 17,708 Cash paid during the year for income taxes 286 4,617 3,815 Supplemental schedule of noncash investing and financing activities: Minimum pension liability adjustment to other assets $ (1,083) 23 806 Minimum pension liability adjustment to other liabilities (1,083) 23 806
See accompanying notes to consolidated financial statements. -22- 23 RENCO METALS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements October 31, 1999, 1998, and 1997 (Dollars in thousands) (1) PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION Renco Metals, Inc. (Renco Metals) is a holding company incorporated in Delaware in July 1993, and is a 100 percent owned subsidiary of The Renco Group, Inc. (Group). The accompanying consolidated financial statements include the accounts of Renco Metals and its wholly-owned subsidiaries, Magnesium Corporation of America (Magcorp) and Sabel Industries, Inc. (Sabel) (collectively the Company). Intercompany transactions and balances have been eliminated. Magcorp's 50 percent-owned affiliate is accounted for under the equity method. Renco Metals is a holding company that has no independent operations, and its only assets are cash and its investments in Magcorp and Sabel. Magcorp owns and operates a magnesium production plant on the Great Salt Lake at Rowley, Utah, and sells pure magnesium and magnesium alloys to domestic and international customers. Sabel is a diversified company in the southeast United States primarily involved in the steel service center, scrap metal, and rebar businesses. Renco Metal's senior notes are unconditionally and fully guaranteed, jointly and severally, by both of its subsidiaries, Magcorp and Sabel (the Guarantors). Separate financial statements of the Guarantors are not presented because, in management's opinion, such financial statements would not be material to investors. Summarized financial information on the combined Guarantors is presented below: SUMMARIZED COMBINED GUARANTOR FINANCIAL INFORMATION
YEARS ENDED OCTOBER 31, -------------------------------------------- 1999 1998 1997 -------- -------- -------- Combined Guarantor statement of operations data: Net sales $179,613 189,699 191,614 Cost of sales 127,694 125,823 129,093 Net income 5,222 10,452 11,748 OCTOBER 31, -------------------------- 1998 1999 -------- -------- Combined Guarantor balance sheet data: Current assets $ 78,701 84,349 Noncurrent assets 45,508 41,024 Current liabilities 14,701 16,300 Noncurrent liabilities 14,922 19,809
-23- 24 RENCO METALS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements October 31, 1999, 1998, and 1997 (Dollars in thousands) (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) CASH AND CASH EQUIVALENTS For purposes of reporting cash flows, the Company considers all highly liquid financial instruments purchased with an original maturity to the Company of three months or less to be cash equivalents. Cash equivalents consist of the following:
1999 1998 ------- ------- Money market funds $ 1,314 10,787 Certificates of deposit 211 203 ------- ------- $ 1,525 10,990 ======= =======
(b) INVENTORIES Inventories are stated at the lower of cost or market, using either weighted average, last-in, first-out (LIFO), or first-in, first-out (FIFO). (c) PROPERTY, PLANT, AND EQUIPMENT Property, plant, and equipment are carried at cost. Depreciation is computed primarily on the straight-line method over the estimated useful lives of the related assets. Expenditures for normal repairs and maintenance are charged to expense as incurred. (d) OTHER ASSETS Other assets include financing costs associated with long-term debt. The costs are being amortized using the straight-line method over the period of the related long-term debt. Other assets consist of the following:
1999 1998 ------ ------ Loan origination and financing fees $6,550 6,680 Unrecognized pension prior service cost 149 1,232 Deposits and other 48 29 ------ ------ 6,747 7,941 Less accumulated amortization 3,101 2,302 ------ ------ $3,646 5,639 ====== ======
-24- 25 RENCO METALS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements October 31, 1999, 1998, and 1997 (Dollars in thousands) (e) DEFERRED COMPENSATION Magcorp and Sabel each have deferred compensation agreements with certain key employees in the form of net worth appreciation participation agreements. The deferred compensation is based on the cumulative net income, as defined in the agreement, of the respective company from a specified date. The aforementioned agreements have been accounted for as deferred compensation in the accompanying consolidated financial statements. (f) OTHER LIABILITIES POSTRETIREMENT HEALTH CARE BENEFITS Magcorp provides postretirement health care benefits to substantially all of its salaried employees. The liability is accrued over the employee's estimated period of employment based on actuarially determined amounts. Benefits are funded as costs are actually incurred. ENVIRONMENTAL COMPLIANCE COSTS Industrial companies such as Magcorp and Sabel have in recent years become subject to increasingly demanding environmental standards imposed by federal, state, and local environmental laws and regulations. It is the policy of the Company to endeavor to comply with applicable environmental laws and regulations. The Company considers current information, environmental laws and regulations, and adjusts its related accruals as considered necessary. (g) INCOME TAXES On January 15, 1999, Group filed an election with the consent of its shareholders with the Internal Revenue Service to change its taxable status from that of a subchapter C corporation to that of a subchapter S corporation, effective November 1, 1998. At the same time, Group elected for the Company to be treated as a qualified subchapter S subsidiary (QSSS). Most states in which the Company operates will follow similar tax treatment. QSSS status requires the ultimate shareholders to include their pro rata share of the Company's income or loss in their individual tax returns. The Company will continue to provide for state and local income taxes for the taxing jurisdictions that do not recognize QSSS status, however, management believes this is not material to the Company. However, under the "built in gains" provisions of the tax law, federal and state taxes may become payable and would be charged to the Company's consolidated statement of income. Such taxes are measured by the excess of the fair market value of assets over their tax bases on the effective date of the subchapter S subsidiary election if the associated assets are disposed of within the ten-year post-election period. It is not management's present intention to trigger any taxes under the built-in-gain provisions of the tax law. -25- 26 RENCO METALS, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows October 31, 1999, 1998, and 1997 (Dollars in thousands) (h) USE OF ESTIMATES IN PREPARATION OF CONSOLIDATED FINANCIAL STATEMENTS The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (i) RESEARCH AND DEVELOPMENT COSTS Research and development costs, included in selling, general, and administrative expenses in the accompanying consolidated financial statements, are expensed as incurred and totaled $1,863, $2,599, and $2,263 for 1999, 1998, and 1997, respectively. (j) FINANCIAL INSTRUMENTS The carrying value of accounts receivable, accounts payable, and accrued expenses approximates their estimated value due to the relative short maturity of these instruments. (k) COMPREHENSIVE INCOME The Company adopted Statement of Financial Accounting Standard No. 130 ("SFAS 130"), Reporting Comprehensive Income, effective November 1, 1998. SFAS 130 establishes standards for reporting and display of comprehensive income and its components in financial statements. For each of the years in the three-year period ended October 31, 1999, comprehensive income was equal to the net income presented in the accompanying consolidated statements of income. (l) RECLASSIFICATIONS Certain reclassifications have been made to the 1998 and 1997 consolidated financial statements to conform to the 1999 presentation. (3) INVENTORIES
Inventories consist of the following: 1999 1998 ------- ------- Finished goods $34,985 24,906 Brine in ponds 1,228 1,100 Spare parts and supplies 9,076 10,310 Raw materials and work-in-process 963 743 ------- ------- 46,252 37,059 Less LIFO reserve 1,273 534 ------- ------- $44,979 36,525 ======= =======
-26- 27 RENCO METALS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements October 31, 1999, 1998, and 1997 (Dollars in thousands) (4) PROPERTY, PLANT, AND EQUIPMENT Property, plant, and equipment are summarized as follows:
DEPRECIABLE LIVES 1999 1998 ------------ ---------- --------- Land - $ 719 519 Buildings 30 7,587 6,232 Equipment 7-15 87,455 73,935 Leasehold improvements 3-5 970 859 Construction-in-process - 5,415 5,828 ---------- --------- 102,146 87,373 Less accumulated depreciation and 60,284 51,988 amortization ---------- --------- $ 41,862 35,385 ========== ========= (5) LONG-TERM DEBT Long-term debt is summarized as follows: 1999 1998 ---------- --------- For Renco Metals: 11.5% senior notes (a) $ 150,000 150,000 For Magcorp: Revolving credit facility (b) - - For Sabel: Revolving credit facility (b) 2,813 4,538 9.7% mortgage note 416 439 ---------- --------- Total long-term debt 153,229 154,977 Less current installments 25 23 ---------- --------- Long-term debt, excluding current installments $ 153,204 154,954 ========== =========
The aggregate maturities of long-term debt for each of the twelve-month periods subsequent to October 31, 1999 are as follows: 2000, $25; 2001, $28; 2002, $2,843; 2003, $150,333; and thereafter, none. -27- 28 RENCO METALS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements October 31, 1999, 1998, and 1997 (Dollars in thousands) As of October 31, 1999, the fair value of the 11.5% Senior Notes was approximately $122,000, based on estimates obtained from brokers. The carrying values of the revolving credit facility and mortgage note are not materially different from the estimated fair value. (a) 11.5% SENIOR NOTES In July of 1996, Renco Metals issued $150,000 aggregate principal amount of 11.5% Senior Notes due July 1, 2003 (the Notes). The Notes are general unsecured obligations of Renco Metals, and are unconditionally and fully guaranteed, jointly and severally, by the Guarantors. Secured indebtedness of the Guarantors, including borrowings under the Revolving Credit Facilities described below, is senior in right of payments to the Notes with respect to the assets securing such indebtedness. Interest on the Notes is payable semiannually on January 1 and July 1 of each year. Except under certain circumstances defined in the indenture governing the Notes, the Notes are not redeemable prior to July 1, 2000. Thereafter, the Notes are redeemable in whole or part, at the option of Renco Metals, at redemption prices ranging from 105.75 percent to 100 percent of the principal amount, depending on the date of redemption. The indenture governing the Notes contains certain covenants, that, among others, limit the type and amount of additional indebtedness that may be incurred by Renco Metals and impose limitations on investments, loans, advances, the payment of dividends and making of certain other payments, the creation of liens, certain transactions with affiliates, and certain mergers. At October 31, 1999, Renco Metals was in compliance with all applicable covenants. (b) REVOLVING CREDIT FACILITIES Magcorp and Sabel each have revolving credit facility agreements that provide for advances by the lender based on specified percentages of eligible accounts receivable and inventories to a maximum of $33,000 for Magcorp and $7,000 for Sabel. Advances bear interest at the prime rate plus three quarters of one percent, payable monthly, and are secured primarily by all receivables and inventories of the borrower. In addition, the lender may extend up to $5,000 and $1,500 of letter of credit accommodations to Magcorp and Sabel, respectively, within the limits set forth above. Outstanding letters of credit under the agreements at October 31, 1999 total $1,621 for Magcorp and none for Sabel. Based on these criteria as of October 31, 1999, the unused amounts available to Magcorp and Sabel were approximately $29,700 and $4,200, respectively. The revolving credit facilities will continue until August 2002 and from year to year thereafter, provided that either Magcorp or Sabel, as the case may be, or the lender may terminate either of the facilities as of August 31, 2002, or any subsequent anniversary date on 60 days advance written notice. The revolving credit facilities contain various covenants and restrictions including financial covenants, which specify that Magcorp and Sabel maintain specified ratios or minimum financial amounts with regard to net worth and working capital, as well as restrictions regarding additional indebtedness, liens, loans, dividends, and transactions with affiliates. At October 31, 1999, Magcorp and Sabel were in compliance with all applicable covenants. -28- 29 RENCO METALS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements October 31, 1999, 1998, and 1997 (Dollars in thousands) (6) INVESTMENT IN AFFILIATE Magcorp has a 50 percent investment in KemMag LLC, (KemMag), a joint venture that sells iron salts. Sales and cost of sales of Magcorp include iron salts supplied to KemMag at cost, in the amount of $1,569 in 1999, $1,703 in 1998, and $1,626 in 1997. Condensed unaudited financial statement information of KemMag follows:
YEARS ENDED OCTOBER 31, ------------------------------- 1999 1998 1997 -------- -------- -------- Income statement information: Sales $ 5,143 4,558 4,442 Net income 760 96 170 OCTOBER 31, ------------------- 1999 1998 -------- -------- Balance sheet information: Current assets $ 943 645 Current liabilities 1,635 2,097 -------- -------- Net deficit $ (692) (1,452) ======== ========
Magcorp has historically provided financial support to KemMag and intends to continue this practice. Accordingly, the Company has recognized cumulative losses in excess of its investment. The carrying value of Magcorp's investment is included in other liabilities in the accompanying consolidated balance sheets and is calculated as follows:
1999 1998 -------- -------- Investment $ 1 1 Advances - 50 Equity in losses of KemMag (347) (727) -------- -------- (346) (676) ======== ========
-29- 30 RENCO METALS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements October 31, 1999, 1998, and 1997 (Dollars in thousands) (7) INCOME TAXES As a result of the change in tax status described in note 1(g), the Company recognized a net income tax benefit of $1,963 during 1999, which includes the elimination of the net deferred tax liability recorded as of October 31, 1998, partially offset by a $100 charge related to the LIFO reserve recapture. A corresponding amount has been presented as a capital contribution in the accompanying consolidated financial statements, since Group paid the tax on behalf of the Company. As of October 31, 1999, the Company's book bases in its assets and liabilities exceeded its tax bases by approximately $3,200. The provision for income tax expense for the years ended October 31, 1998 and 1997 is comprised of the following:
1998 1997 -------- -------- Federal: Current $ 3,715 4,317 Deferred 10 (64) -------- -------- Total 3,725 4,253 ======== ======== State: Current 802 833 Deferred (185) (123) -------- -------- Total $ 617 710 ======== ========
The statutory federal income tax rate is reconciled to the effective income tax rate for 1998 and 1997 are as follows:
1998 1997 -------- -------- Computed "expected" tax expense $ 5,179 5,856 State and local tax, net of federal benefit 402 523 Depletion (1,060) (1,374) Change in deferred tax asset valuation allowance (66) - Other (113) (42) -------- -------- Income tax provision $ 4,342 4,963 ======== ========
Deferred income taxes result from temporary differences in the book basis and tax basis of assets and liabilities. Total deferred tax assets and deferred tax liabilities amounted to approximately $3,117 and $4,353, respectively, as of October 31, 1998. The most significant items comprising the deferred tax assets were postretirement benefits of $1,106 and compensation accruals of $870 while deferred tax liabilities consisted primarily of deferred taxes on inventory of $827 and fixed assets of $3,526. The Company had a valuation allowance of $827 for realization of deferred tax assets as of October 31, 1998. -30- 31 RENCO METALS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements October 31, 1999, 1998, and 1997 (Dollars in thousands) (8) RELATED PARTY TRANSACTIONS Group provides management services to the Company under a management agreement. Such services include operational consulting, budget review, income tax consulting, and contracting for insurance under master policies. Pursuant to the agreement, Group provides such services to the Company for an annual management fee of $1,200. The management agreement extends to October 31, 2000, and continues thereafter for additional three-year terms unless sooner terminated by either party giving six months prior written notice. The Company paid management fees to Group of $1,200 for each of the years in the three-year period ended October 31, 1999. Magcorp has $318 payable to Group at October 31, 1999 and 1998 that is noninterest bearing. The payable is included in other liabilities in the accompanying consolidated balance sheets and is subordinated to the liabilities described in note 5. During 1998 and 1997, the Company paid to Group dividends totaling $7,200 and $6,600, respectively. (9) EMPLOYEE BENEFIT PLANS Magcorp Hourly Defined Benefit Pension Plan and Salaried Postretirement Medical Plan Pension benefits under Magcorp's defined benefit plan for hourly employees are generally based on a flat dollar amount times years of credited service. Magcorp's funding policy is to contribute amounts sufficient to satisfy regulatory funding standards, based upon independent actuarial valuations. Magcorp's self-insured, fee-for-service postretirement medical benefit plan provides health care benefits to salaried retirees who retire from active employment status on or after age 65 with ten or more years of service. Qualified retirees receive lifetime benefits for themselves. The retiree's spouse also receives coverage that continues for one year after the retiree's death. Employees who retire on or after age 55 with less than ten years but at least five years or more of service receive benefits only after age 65. -31- 32 RENCO METALS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements October 31, 1999, 1998, and 1997 (Dollars in thousands) The following provides a reconciliation of benefit obligations, plan assets, and funded assets of the plans:
OTHER PENSION POSTRETIREMENT BENEFITS BENEFITS ------------------ ------------------- 1999 1998 1999 1998 ------ ------- ------- ------- Change in benefit obligation: Beginning of year $ 6,765 5,919 2,925 2,563 Service cost 303 292 119 106 Interest cost 471 427 204 185 Actuarial (gain) loss (1,072) 214 (19) 112 Benefits paid (154) (87) (76) (41) ------- -------- ------- ------- End of year 6,313 6,765 3,153 2,925 Change in plan assets: Fair value at beginning of year 5,511 4,555 Actual return on plan assets 371 514 Employer contributions - 530 Benefits paid (155) (88) ------- -------- Fair value at end of year 5,727 5,511 Reconciliation of funded status: Funded status (586) (1,254) (3,153) (2,925) Unrecognized actuarial gain (1,275) (300) (3,626) (3,848) Unrecognized prior service cost 1,424 1,532 - - ------- -------- ------- ------- Net amount recognized (437) (22) (6,779) (6,773) ======= ======= Amounts recognized in the consolidated balance sheets: Accrued benefit liability (586) (1,254) Intangible asset 149 1,232 ------- ------ Net amount recognized $ (437) (22) ======= ====== Assumptions (weighted average): Discount rate 7.75% 7.00% 7.75% 7.00% Expected return on plan assets 8.25% 8.25%
For measurement purposes, a 7.5 percent annual rate of increase in the per capita cost of covered health care benefits was assumed for 1999. The rate was assumed to decrease gradually to 4.5 percent over ten years and remain at that level. -32- 33 RENCO METALS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements October 31, 1999, 1998, and 1997 (Dollars in thousands) Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plan. A one-percentage-point change in assumed health care cost trend rates would have the following effects:
ONE-PERCENTAGE-POINT ---------------------- INCREASE DECREASE -------- -------- Effect on total of service and interest cost components $ 32 (34) Effect on postretirement benefit obligation 294 (304)
Net periodic pension and other postretirement benefit costs include the following components:
OTHER PENSION POSTRETIREMENT BENEFITS BENEFITS ---------------------- ---------------------- 1999 1998 1997 1999 1998 1997 ----- ------ ------ ----- ------ ------ Components of net periodic benefit cost Service cost $ 303 292 202 118 106 166 Interest cost 471 427 314 204 185 239 Expected return on assets (467) (384) (306) - - - Amortization of unrecognized net gain - - - (240) (270) (202) Amortization of prior year service cost 108 108 38 - - - ----- ------ ------ ----- ------ ------ Net periodic benefit cost $ 415 443 248 82 21 203 ===== ====== ====== ===== ====== ======
The unrecognized net gain in the postretirement medical plan is being amortized over a period of approximately fifteen years, which represents the average future working lifetime of the plan participants. Thrift Plans and Salary Defined Contribution Plan Magcorp has a salaried thrift plan and an hourly thrift plan that qualify under the Internal Revenue Code Section 401(k). The plans are available to substantially all employees. Magcorp may make discretionary matching contributions of 50 percent of each hourly employee's contribution, and 75 percent of each salaried employee's contribution, up to the first six percent of the employee's compensation. Matching contributions were $474, $447, and $442 for 1999, 1998, and 1997, respectively. Contributions for Magcorp's defined contribution plan are based upon age, years of service, and gross compensation for each salaried employee, and totaled approximately $813, $735, and $557, for 1999, 1998, and 1997, respectively. -33- 34 RENCO METALS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements October 31, 1999, 1998, and 1997 (Dollars in thousands) Sabel Under an agreement with the United Steelworkers' Union, which covers certain production employees, Sabel contributes to a pension plan based on a set amount per hour worked for covered employees. The contributions to the plan were $84, $90, and $82 for 1999, 1998, and 1997, respectively. Sabel has a noncontributory profit sharing plan for management and administrative employees. The amount of the annual contribution, if any, is at the discretion of Sabel and is not to exceed 15 percent of the compensation of the eligible employees. Contributions to the plan were $115 in 1999. No contributions were made in 1998 or 1997. (10) LEASES The Company has several noncancelable operating leases, primarily for office and warehouse space, and machinery and equipment. These leases generally contain renewal options. Future minimum lease payments under noncancelable operating leases (with initial or remaining lease terms in excess of one year) as of October 31, 1999 are listed below:
YEAR ENDING OCTOBER 31: 2000 $ 1,928 2001 1,583 2002 1,046 2003 556 2004 352 Thereafter 91 ------- Total minimum lease payments $ 5,556 =======
Rent expense aggregated $2,628, $4,101, and $2,412 for 1999, 1998, and 1997, respectively. Included in rental expense was contingent rental expense of approximately $152, $118, and $73 for 1999, 1998, and 1997, respectively. Additionally, included in rental expense are leases of certain office and warehouse space from entities in which the president of Sabel holds an indirect material interest. Rent expense for such leases aggregated approximately $383, $383, and $336 for 1999, 1998, and 1997, respectively. -34- 35 RENCO METALS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements October 31, 1999, 1998, and 1997 (Dollars in thousands) (11) COMMITMENTS AND CONTINGENCIES (a) LITIGATION In April 1998, the United States filed a complaint against Magcorp in the U.S. District Court for the District of Utah, seeking damages, including treble damages, in alleging that Magcorp has taken magnesium out of mineral-laden ground water belonging to the United States without a mineral lease or payment of royalties. Management strongly believes this claim is based on the erroneous assumption that the disputed minerals came from groundwater belonging to the United States. Management strongly disputes the United States' claims, and believes that the source of the disputed minerals is the water pumped from the Great Salt Lake to the West Desert by the State of Utah - not groundwater - and that the Company properly purchased those minerals pursuant to an agreement with the State of Utah. In 1999 the United States added the State of Utah as a defendant. Like Magcorp, the State of Utah denies the allegations in the United States' complaint. The United States has to date not produced any evidence to support its claims. Management is vigorously defending against the claims and in the opinion of management, after consulting with legal counsel, the ultimate resolution of this uncertainty will not result in a future loss that would be material to the Company's financial condition, results of operations, or liquidity. The Company and its subsidiaries are involved in other litigation arising in the normal course of business. It is not possible to state the ultimate liability, if any, in these matters. In the opinion of management, based upon the advice of outside counsel, such litigation will not have any material effect on the Company. (b) OTHER AGREEMENTS Magcorp and Sabel both have net worth appreciation participation agreements with certain executives wherein these individuals are entitled to receive a specified percentage of cumulative net income, less any common stock dividends, of their respective companies commencing at specified dates in the agreements, through the date of the individual's termination based on a specified vesting schedule. Payment will be made in 40 equal quarterly installments, without interest, commencing three months after termination of employment. If Magcorp or Sabel pays any cash dividend on its common stock during the term of the employment of the applicable executives, the respective company will make a cash payment to such executives equal to the total amount of the cash dividend multiplied by their applicable fully-vested participation percentage. Amounts are accrued as earned. -35- 36 RENCO METALS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements October 31, 1999, 1998, and 1997 (Dollars in thousands) (c) ENVIRONMENTAL MATTERS The Company is and will continue to be subject to numerous federal and state environmental laws and regulations governing, among other things, air emissions, waste water discharge, and solid and hazardous waste disposal. The Company believes that it has made and intends to continue to make the necessary expenditures for compliance with environmental laws and regulations. Environmental laws and regulations have changed rapidly in recent years, and the Company may be subject to more stringent environmental laws and regulations in the future. The Company cannot currently assess the impact of more stringent standards on its results of operations or financial condition. Magcorp plans to spend a minimum of $30,000 of its capital expenditure budget for 2000 and 2001, in an electrolytic cell conversion program designed to meet environmental regulatory requirements, and for anticipated other future requirements. There can be no assurance that Magcorp's program will be successful, and to the extent it is not successful, it could have a material adverse effect on the Company's financial condition and results of operations. (12) ACCRUED EXPENSES Accrued expenses consist of:
1999 1998 -------- ------- Utilities $ 3,075 1,854 Salaries, bonuses, vacation, and other related accruals 1,917 3,131 Interest 5,750 5,750 Taxes, other than income 579 581 Other 2,973 3,736 -------- ------- $ 14,294 15,052 ======== =======
-36- 37 RENCO METALS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements October 31, 1999, 1998, and 1997 (Dollars in thousands) (13) SEGMENT INFORMATION The Company classifies its operations into two operating segments: magnesium production and steel wholesaling and fabrication. The accounting policies of the segments are the same as those described in the summary of significant accounting policies (note 2). Management evaluates a segment's performance based upon operating income. There are no intersegment sales, allocated costs, or jointly used assets. Summarized financial information by operating segment follows.
1999 1998 1997 -------- -------- -------- Revenues: Magnesium $ 134,728 141,333 147,113 Steel 44,885 48,366 44,501 -------- -------- -------- Consolidated revenues $ 179,613 189,699 191,614 ======== ======== ======== Profit or loss: Income from operations: Magnesium $ 19,056 30,921 32,825 Steel 2,044 1,640 1,444 -------- -------- -------- Total reportable segments 21,100 32,561 34,269 -------- -------- -------- Other income (expense), net (17,745) (17,764) (17,538) -------- -------- -------- Consolidated income before income taxes $ 3,355 14,797 16,731 ======== ======== ======== Assets: Magnesium $ 108,340 108,034 107,460 Steel 15,869 16,926 16,124 -------- -------- -------- Total reportable segments 124,209 124,960 123,584 -------- -------- -------- Other assets 1,882 1,689 3,247 -------- -------- -------- Consolidated assets $ 126,091 126,649 126,831 ======== ======== ======== Capital expenditures: Magnesium $ 15,146 5,827 7,492 Steel 525 187 1,112 -------- -------- -------- Consolidated capital expenditures $ 15,671 6,014 8,604 ======== ======== ======== Depreciation, depletion, and amortization: Magnesium $ 8,678 7,838 7,054 Steel 453 451 397 -------- -------- -------- Consolidated depreciation, depletion, and amortization $ 9,131 8,289 7,451 ======== ======== ========
-37- 38 RENCO METALS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements October 31, 1999, 1998, and 1997 (Dollars in thousands) (14) SIGNIFICANT CUSTOMERS AND EXPORT SALES During 1999, 1998, and 1997, sales to any single customer did not exceed ten percent of total consolidated revenues. All of the Company's long-lived assets are located in the United States. However, the Company sells and ships products to many foreign countries. The following table summarizes export sales to various geographic areas:
1999 1998 1997 ------- ------- ------- Net export sales: Germany $ 6,134 3,495 3,832 Canada 2,747 1,389 1,165 Japan 1,156 1,442 2,132 France 1,108 1,030 1,218 Other 781 1,562 1,420 ------- ------- ------- $11,926 8,918 9,767 ======= ======= =======
-38- 39 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The following table sets forth certain information regarding the directors and executive officers of the Company, Magcorp and Sabel:
NAME AGE POSITION Ira Leon Rennert.......65 Chairman, Director and Chief Executive Officer of the Company, Chairman of Magcorp and Sabel Roger L. Fay...........54 Vice President, Finance of the Company Michael H. Legge.......53 President and Chief Executive Officer of Magcorp Keith Sabel............50 Director, President and Chief Executive Office of Sabel Justin W. D'Atri.......72 Director of Sabel Howard I. Kaplan.......55 Vice President of Sales and Marketing of Magcorp Ron L. Thayer..........40 Vice President of Operations of Magcorp Lee R. Brown...........53 Vice President of Public and Governmental Affairs of Magcorp Todd R. Ogaard.........44 Vice President of Finance and Administration of Magcorp Phillip B. Brown.......52 Vice President of Finance and Treasurer of Sabel Frederick F. Callahan..49 Vice President of Sabel
IRA LEON RENNERT has been the Chairman, Chief Executive Officer and sole member of the Board of Directors of the Company since its inception and has been the Chairman, CEO and principal shareholder of Group since its first acquisition in 1975. Group holds controlling interests in a number of manufacturing and distribution concerns operating in businesses not competing with the Company, including WCI Steel, Inc. and its parent company, Renco Steel Holdings, Inc., AM General Corporation, The Doe Run Resources Corporation, and Lodestar Holdings, Inc., for all of which Mr. Rennert serves as a Director. ROGER L. FAY has been Vice President, Finance for the Company since its inception and has been Vice President, Finance for Group since 1983. Mr. Fay is a certified public accountant. Before joining Group, Mr. Fay served for twelve years as a controller of one of Group's subsidiaries. MICHAEL H. LEGGE was appointed President and Chief Executive Officer of Magcorp on January 1, 1993. He was previously Vice President of Operations at the Rowley facility and has served in several managerial and technical positions since joining NL Industries, Inc., a predecessor of Magcorp, in 1979. KEITH SABEL has served in his present position as President and Chief Executive Officer of Sabel since 1990 and is also a director of Sabel. Mr. Sabel has been with Sabel in various positions since 1973. JUSTIN W. D'ATRI, a practicing attorney in New York, New York from 1952 until his retirement in June 1996, has been Secretary and a director of, and legal counsel for, Group since its inception and is now a consultant to Group, and has been Secretary of the Company since its incorporation. Mr. D'Atri has been the Secretary and a director of Sabel since 1987 and Secretary of Magcorp since August 1989. HOWARD I. KAPLAN has served in his present position as Vice President of Sales and Marketing of Magcorp since 1986. Dr. Kaplan joined AMAX Magnesium, a predecessor of Magcorp, in 1981 and served as Manager of Technical Market Development, Process Control Superintendent and Electrolytics and Cast House Superintendent. Dr. Kaplan has a Ph.D. from the University of Pennsylvania in Metallurgy and Materials Science. -39- 40 RON L. THAYER has served in his present position since January 1, 1993. He was previously Operations Superintendent at the Rowley facility and has served in several managerial and technical positions since joining AMAX Magnesium, a predecessor of Magcorp, in 1988. Prior to joining AMAX Magnesium, Mr. Thayer was with Williams Resources, a chemical company in Denver, Colorado. LEE R. BROWN has been Vice President of Human Resources at Magcorp since 1984. Mr. Brown joined NL Industries, Inc., a predecessor of Magcorp, in 1978. Prior to joining NL Industries, he spent two years with Kennecott Copper. TODD R. OGAARD joined Magcorp in February 1994 and assumed Vice President of Finance responsibilities effective February 1995. Mr. Ogaard is a certified public accountant. Prior to joining Magcorp, he was a Senior Manager with the accounting and consulting firm of KPMG LLP and had been with that firm in various capacities from September 1981 through January 1994. PHILLIP B. BROWN joined Sabel in 1975. He has served as comptroller since 1977, and assumed Vice President of Finance and Treasurer responsibilities in 1999. FREDERICK F. CALLAHAN served as purchasing agent manager at Sabel from 1988 to 1992. After five years in other employment, Mr. Callahan rejoined Sabel in 1997 as sales manager, and assumed Vice President responsibilities in 1999. ITEM 11. EXECUTIVE COMPENSATION. The following table sets forth certain information concerning compensation of the named executive officers by the Company for services rendered to it in all capacities during fiscal 1999, 1998 and 1997:
Long-term Compen- sation Name and Annual Compensation (1) ----------- All Other Principal ---------------------- LTIP Compen- Position Year Salary Bonus Payouts (3) sation - ------------------------------------------------ ----- -------- ------- ----------- -------------- Ira Leon Rennert (2) 1999 $ - $ - $ - $1,200,000 (2) Chairman and Chief Executive Officer 1998 - - - 1,200,000 (2) 1997 - - - 1,200,000 (2) Michael H. Legge 1999 220,756 200,000 - 29,531 (4) President and Chief Executive Officer of Magcorp 1998 153,333 250,000 216,000 24,419 (4) 1997 120,756 250,000 198,000 24,139 (4) Keith Sabel 1999 188,525 20,000 - 5,401 (5) President and Chief Executive Officer of Sabel 1998 135,887 50,000 - - 1997 131,915 50,000 - - Howard I. Kaplan 1999 120,000 75,000 - 25,460 (4) Vice President of Sales and Marketing of Magcorp 1998 103,149 110,000 72,000 24,915 (4) 1997 94,723 100,000 66,000 22,026 (4) Ron L.Thayer 1999 120,756 100,000 - 8,018 (4) Vice President of Operations of Magcorp 1998 96,592 130,000 72,000 6,400 (4) 1997 85,550 100,000 66,000 5,850 (4) - ------------------------------------------------
(1) Value of perquisites per individual did not exceed the lesser of $50,000 or 10% of total salary and bonus per named executive officer. (2) Mr. Rennert receives no cash compensation directly from the Company. He is Chairman of the Board. All of the Company's issued and outstanding capital stock is owned by Group, which is owned through trusts established by him for himself and members of his family. Group receives a management fee from the Company pursuant to a management agreement. The amount shown includes the $1.2 million annual management fee paid by the Company to Group for each fiscal year. See "ITEM 13. Certain Relationships and Related Transactions." (3) The amounts shown as "LTIP Payouts" in the table for each named executive officer represent contractual payments under such officer's Net Worth Appreciation Agreement. See "--Net Worth Appreciation Agreements" below. -40- 41 (4) The other compensation shown consists of employer contributions to a defined contribution pension plan and matching contributions under Magcorp's 401(k) savings plan. (5) Consists of employer contributions to a noncontributory profit sharing plan. Compensation Committee Interlocks and Insider Participation The Company had no compensation committee during fiscal 1999. The sole member of the Board of Directors was Mr. Rennert. The compensation for the executive officers is fixed by negotiations between such executive officers and Mr. Rennert acting on behalf of Group. During 1999, no executive officer of the Company served (a) as a member of the compensation committee (or other board committee performing equivalent functions or, in the absence of any such committee, the entire board of directors) of another entity, one of whose executive officers served on the Company's board of directors, (b) as a director of another entity, one of whose executive officers served on the Company's board of directors or (c) as a member of the compensation committee (or other board committee performing equivalent functions or, in the absence of any such committee, the entire board of directors) of another entity, one of whose executive officers served as a Director of the Company. Employment Agreements Mr. Legge is employed by Magcorp pursuant to an employment agreement effective as of January 1, 1993 and as amended July 22, 1998, which continues until December 31, 2000 and for additional one-year periods thereafter unless terminated by either party by written notice given 30 days prior to the then current expiration date. Pursuant to such employment agreement, Mr. Legge will receive a base minimum annual salary of $220,000 and a bonus of at least $35,000 for each year in which Magcorp is profitable. Dr. Kaplan is employed by Magcorp pursuant to an employment agreement effective as of June 1, 1994 and as amended July 22, 1998, which continues until October 31, 2000 and for additional one-year periods thereafter unless terminated by either party by written notice given six months prior to the then current expiration date. Pursuant to such employment agreement, Mr. Kaplan will receive a base minimum annual salary of $120,000 and a bonus of at least $25,000 for each year in which Magcorp is profitable. Mr. Thayer is employed by Magcorp pursuant to an employment agreement effective as of January 1, 1993 and as amended July 22, 1998, which continues until December 31, 2000 and for additional one-year periods unless terminated by either party by written notice given 30 days prior to the then current expiration date. Pursuant to such employment agreement, Mr. Thayer will receive a base minimum annual salary of $120,000 and a bonus of at least $20,000 for each year in which Magcorp is profitable. Net Worth Appreciation Agreements Mr. Legge, Dr. Kaplan, Mr. Thayer, Mr. Brown and Mr. Ogaard are each parties to Net Worth Appreciation Agreements ("NWAP Agreements") with Magcorp, under which each will be entitled to receive a fixed percentage of the increase in the cumulative net income of Magcorp from August 1, 1996 until the end of the fiscal quarter preceding the date of the termination of his employment or, if the employee leaves voluntarily, following the expiration of 30 days after his giving notice of resignation. Such amount is payable without interest in 40 equal quarterly installments commencing on the employee's termination, or, if later, the earlier of June 11, 2011 or his attaining the age 62 (or his prior death or disability), and so long as he has not engaged in any business competitive with that of Magcorp subsequent to leaving his employment. The maximum aggregate percentage payable to the five executives is 7% of such increase in the cumulative net income of Magcorp. Mr. Sabel and Mr. Brown are each parties to NWAP Agreements with Sabel entitling them upon leaving the employment of Sabel to receive a fixed percentage of the increase in the net income of Sabel, as defined in the agreements, from August 1, 1993 until the end of the fiscal quarter preceding the date of termination, payable without interest in 40 quarterly installments. Assuming all of the Company's executive officers had retired at October 31, 1999, an aggregate of $935,000 would have been payable to such executive officers pursuant to the NWAP Agreements. The NWAP Agreements also provide that, if while employed by Magcorp or Sabel, the respective company pays certain cash dividends on its common stock, the respective company will make a cash payment to the applicable executive officer equal to the total amount of the cash dividend multiplied by their applicable fully vested participation percentage. In conjunction with the Company's dividends to Group, Magcorp's Board of Directors -41- 42 declared and paid to Renco Metals dividends totaling $7.2 million in 1998 and $6.6 million in 1997. Accordingly, an aggregate of $504,000 in 1998 and $462,000 in 1997 was paid to the five Magcorp executive officers covered by Magcorp's NWAP Agreements. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The following table sets forth the beneficial ownership of the outstanding equity securities of the Company as of January 27, 2000:
NAME AND ADDRESS OF AMOUNT AND NATURE OF PERCENT TITLE OF CLASS BENEFICIAL OWNER BENEFICIAL OWNERSHOF CLASS -------------- ---------------- -------------------- ----- Common stock, no par The Renco Group, Inc. 1,000 shares, Direct 100% value................... (1) Ira Leon Rennert(2) c/o The Renco Group 1,000 shares 100% Inc.(1) All directors and executive officers as 1,000 shares 100% a group(2)
- --------------------- (1) The address of Group is 30 Rockefeller Plaza, Suite 4225, New York, NY 10112. (2) All of the Company's issued and outstanding capital stock is owned by Group, which is owned through trusts established by Mr. Rennert for himself and members of his family. Mr. Rennert may be deemed to be the beneficial owner of the Company's capital stock. Roger L. Fay, Vice President, Finance of the Company, is Vice President, Finance and a director of Group. Justin W. D'Atri, Secretary of the Company and the Subsidiaries, is Secretary and a director of Group and one of the trustees of the trusts mentioned in above. No other executive officer of the Company or the Subsidiaries has any interest in Group. By virtue of Group's ownership of all the outstanding shares of capital stock of the Company, and. the ownership by Mr. Rennert's trusts of the capital stock of Group, Mr. Rennert is in a position to control actions that require the consent of a majority of the holders of the Company's outstanding shares of capital stock, including the election of the board of directors. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Management Agreement Group provides management services to the Company under a management agreement (the "Management Agreement"). Such services include operational consulting, budget review, income tax consulting and contracting for insurance under master policies. Pursuant to the Management Agreement, Group provides such services to the Company for an annual management fee equal to $1.2 million. The Management Agreement extends to October 31, 2000, and continues thereafter for additional three-year terms unless sooner terminated by either party by giving six months prior written notice. The Company paid management fees of $1.2 million to Group for each of the years in the three year period ended October 31, 1999. The Company believes that the cost of obtaining the type and quality of services rendered by Group under the Management Agreement was, and continues to be, no less favorable than that at which the Company could obtain such services from unaffiliated entities. Insurance Sharing Program To obtain the advantages of volume, Group purchases certain insurance coverage for its subsidiaries, including the Company, and the actual cost of such insurance, without markup, is reimbursed by the covered subsidiaries. The major areas of the Company's insurance coverage obtained under the Group programs are property, business interruption, general, product and auto liability, casualty umbrella, fidelity, fiduciary and workers' compensation. The premiums for fidelity, fiduciary, property, business interruption, auto liability and casualty umbrella are allocated by Group substantially as indicated in the underlying policies. General and product liability and workers' compensation coverages are loss sensitive programs with both fixed and variable premium components. The fixed premium component for this coverage is allocated to each insured Group subsidiary based on factors that include historical guaranteed cost premium, the overall growth of each subsidiary and an assessment of risk based on loss experience. The fixed component is subject to revision resulting from the insurance carrier's audit of actual premium factors. As claims (the variable component) are paid, each insured within the loss sensitive program is charged for its claims up to a maximum amount and subject to an overall maximum for all insured subsidiaries. -42- 43 Each insured Group subsidiary has been assigned an individual maximum cost based on historical guaranteed cost premiums. The overall and individual subsidiary maximums are subject to revision based on audit of actual premium factors. If an insured Group subsidiary reaches its individual maximum cost, the other insured subsidiaries are required to share proportionately in the excess cost of the subsidiary that has reached its individual maximum. In 1999, the Company incurred costs of approximately $1.2 million under the Group insurance program. The Company believes that its insurance costs under this program were less than it would have incurred if it had obtained its insurance directly. Tax Sharing Agreement Pursuant to a tax sharing agreement between the Company and Group, the Company pays to Group an amount equal to the amount the Company would have been required to pay for taxes on a stand-alone basis to the Internal Revenue Service and the applicable state taxing authority, as the case may be, except that the Company will not have the benefit of any of its tax loss carryforwards unless such tax losses were a result of timing differences between the Company's accounting for tax and financial reporting purposes, which agreement also provides that transactions between the Company and Group and its other subsidiaries are accounted for on a cash basis and not on an accrual basis. On January 15, 1999, Group filed an election with the consent of its shareholders with the Internal Revenue Service to change its taxable status from that of a subchapter C corporation to that of a subchapter S corporation, effective November 1, 1998. At the same time, Group elected for the Company to be treated as a qualified subchapter S subsidiary (QSSS). Most states in which the Company operates will follow similar tax treatment. QSSS status requires the ultimate shareholders to include their pro rata share of the Company's income or loss in their individual tax returns. The Company will continue to provide for state and local income taxes for the taxing jurisdictions that do not recognize QSSS status, however, management believes this is not material to the Company. However, under the "built in gains" provisions of the tax law, federal and state taxes may become payable and would be charged to the Company's statement of income. Such taxes are measured by the excess of the fair market value of assets over their tax bases on the effective date of the subchapter S subsidiary election if the associated assets are disposed of within the ten-year post-election period. It is not management's present intention to trigger any taxes under the built-in-gain provisions of the tax law. Transactions with Sabel Family Sabel leases certain of its facilities from an affiliate of the Sabel family under a lease running to July 31, 2002, which may be extended for an additional term of five years. Total rent payments during 1999 were $383,000. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
A. Documents filed as part of this Form 10-K: 1. Financial Statements (included in Part II, ITEM 8): Independent Auditors' Report 18 Consolidated Balance Sheets - October 31, 1999 and 1998 19 Consolidated Statements of Income - Years ended October 31, 1999, 1998 and 1997 20 Consolidated Statements of Stockholder's Deficit - Years ended October 31, 1999, 1998 and 1997 21 Consolidated Statements of Cash Flows - Years ended October 31, 1999, 1998 and 1997 22 Notes to Consolidated Financial Statements 23 2. Financial Statement Schedules (included in Part IV): Schedule II Valuation and Qualifying Accounts 47
Schedules not listed above have been omitted because the information required to be set forth therein is not applicable or is included in the consolidated financial statements or notes thereto. -43- 44 3. Exhibits
EXHIBIT NO. IDENTIFICATION OF EXHIBITS ----------- -------------------------- 3.1 -- Certificate of Incorporation of Renco Metals, Inc. (1) 3.2 -- Certificate of Incorporation of Magnesium Corporation of (1) America 3.3 -- Certificate of Incorporation of Sabel Industries, Inc. (1) 3.4 -- By-laws of Renco Metals, Inc. (1) 3.5 -- By-laws of Magnesium Corporation of America (1) 3.6 -- By-laws of Sabel Industries, Inc. (1) 4.1 -- Indenture dated as of July 1, 1996 among Renco Metals, (6) Inc., Issuer, Magnesium Corporation of America and Sabel Industries, Inc., Guarantors, and State Street Bank and Trust, successor Trustee, relating to 11-1/2% Senior Notes Due 2003 (with form of Note and form of guarantee annexed) 10.1 -- Employment Agreements between Magnesium Corporation of America and: a) Michael H. Legge, dated September 24, 1992 effective (1) January 1, 1993 b) Ron L. Thayer effective June 1, 1994 (2) c) Howard I. Kaplan dated June 10, 1994 (2) d) Lee R. Brown, dated September 1, 1989 (1) e) Todd R. Ogaard, dated December 1, 1994 (2) 10.1.1 -- Amendments to Employment Agreements between Magnesium Corporation of America and: a) Michael H. Legge (10) b) Ron L. Thayer (10) c) Howard I. Kaplan (10) d) Lee R. Brown (10) e) Todd R. Ogaard (10) 10.2 -- Net Worth Appreciation Agreements between Magnesium Corporation of America and: a) Michael H. Legge, dated September 24, 1992 (1) b) Ron L. Thayer, dated September 24, 1992 (1) c) Lee R. Brown, dated July 30, 1993 (1) d) Howard I. Kaplan, dated June 10, 1994 (2) e) Todd R. Ogaard, dated May 19, 1995 (3) 10.3 -- Amendments to Net Worth Appreciation Agreements between Magnesium Corporation of America and: a) Michael H. Legge (8) b) Ron L. Thayer (8) c) Lee R. Brown (8) d) Todd R. Ogaard (8) e) Howard I. Kaplan (8) 10.4 -- Management Consultant Agreement dated August 4, 1993 between (1) The Renco Group, Inc. and Renco Metals, Inc. 10.5 -- Amendment No. 1 to Management Consultant Agreement dated May (5) 17, 1996 between The Renco Group, Inc. and Renco Metals, Inc. 10.6 -- Amended and Restated Loan and Security Agreement between (1) Congress Financial Corporation and Magnesium Corporation of America dated August 4, 1993 10.7 -- Amendment No. 1 dated January 31, 1996 to Amended and (4) Restated Loan and Security Agreement dated as of August 4, 1993, between Congress Financial Corporation and Magnesium Corporation of America, extending the term thereof to August 4, 1998 10.8 -- Amendment No. 2 dated July 3, 1996 to Amended and (8) Restated Loan and Security Agreement dated as of August 4, 1993, between Congress Financial Corporation and Magnesium Corporation of America 10.8.1 -- Amendment No. 3 dated August 28, 1997 to Amended and (9) Restated Loan and Security Agreement dated as of August 4, 1993, between Congress Financial Corporation and Magnesium Corporation of America 10.8.2 -- Amendment No. 4 dated January 19, 1999 to Amended and (11) Restated Loan and Security Agreement dated as of August 4, 1993, between Congress Financial Corporation and Magnesium Corporation of America 10.8.3 -- Amendment No. 5 dated August 10, 1999 to Amended and (12) Restated Loan and Security Agreement dated as of August 4, 1993, between Congress Financial Corporation and Magnesium Corporation of America
-44- 45
EXHIBIT NO. IDENTIFICATION OF EXHIBITS -- -- --- -- -- -- -- -- -- -- 10.9 -- Loan and Security Agreement between Congress Financial (1) Corporation and Sabel Industries, Inc. dated August 4, 1993 10.10 -- Amendment No. 1 dated January 31, 1996 to Loan and (4) Security Agreement dated as of August 4, 1993, between Congress Financial Corporation and Sabel Industries, Inc., extending the term thereof to August 4, 1998 10.11 -- Amendment No. 2 dated July 3, 1996 to Loan and Security (8) Agreement dated as of August 4, 1993, between Congress Financial Corporation and Sabel Industries, Inc. 10.11.1 -- Amendment No. 3 dated August 28, 1997 to Loan and (9) Security Agreement dated as of August 4, 1993, between Congress Financial Corporation and Sabel Industries, Inc. 10.11.2 -- Amendment No. 4 dated January 19, 1999 to Loan and (11) Security Agreement dated as of August 4, 1993, between Congress Financial Corporation and Sabel Industries, Inc. 10.11.3 -- Amendment No. 5 dated August 10, 1999 to Loan and (12) Security Agreement dated as of August 4, 1993, between Congress Financial Corporation and Sabel Industries, Inc. 10.12 -- Agreement dated July 31, 1969 between the State of Utah, (1) acting by and through the State Land Board, and National Lead Company, as amended by Addendum dated March 7, 1970, Second Addendum dated March 7, 1972 and Assignment to Amax Magnesium Corporation dated October 31, 1980 (ML 18779) 10.13 -- Special Use Lease Agreement 711 dated July 14, 1987 (1) between the State of Utah, Division of State Lands and Forestry and Amax Magnesium Corporation 10.14 -- Amended Rights of Way No. U-54897, dated June 21, 1993 (1) issued by the United States Department of the Interior Bureau of Land Management, Salt Lake District Office to Magnesium Corporation of America 10.15 -- Lease dated May 13, 1991 between Sabel Industries, Inc. (1) as tenant and Janis Sabel, the Estate of Mark Sabel, Marcelle Sabel Moers a/k/a Marcel Sabel Moers, Dorothy Anne Bell and Lee Altheimer as successors to the Estate of Dorothy Altheimer with respect to premises known as Theodore Highway 90, County of Mobile, Alabama 10.16 -- Lease dated July 1, 1977 between Dewey Emfinger and his (1) wife, Bea Emfinger, to Sabel Steel Service Incorporated with respect to premises known at 599 Ross Clark Circle, Dothan, Alabama and the sublease thereof to Sabel Industries, Inc. then known as Ren Alabama Inc. dated July 30, 1987 10.17 -- Lease dated July 30, 1987 between Mark Sabel, Janis (1) Sabel, Marcel Moers and Dorothy Altheimer, owner of an undivided 50% interest and Ted Cohen, owner of an undivided 50% interest, all as tenants in common, to Sabel Industries, Inc. (name subsequently changed to JiMark Investment Company, Inc.) with respect to premises known as 2811 Day Street, Montgomery, Alabama and the sublease thereof to Sabel Industries, Inc., then known as Ren Alabama Inc., dated July 30, 1987. Note: Sabel Industries, Inc. subsequently purchased the undivided 50% interest of Mr. Cohen 10.18 -- Master Lease Indenture dated July 30, 1987 between Sabel (1) Land Company, a tenancy in common, comprised of Mark Sabel, Janis Sabel, Marcel Moers and Dorothy Altheimer and Sabel Industries, Inc. then known as Ren Alabama Inc. covering premises known as Railroad Street, West Lafayette Street, East Lafayette Street, 749 North Court Street and 589 North Court Street, all in Montgomery, Alabama (other premises covered by this original lease are no longer used by Sabel Industries, Inc.) 10.19 -- Brine Supply Agreement dated August 3, 1993 between AZKO (1) Salt Inc. and Magnesium Corporation of America 10.20 -- Net Worth Appreciation Agreements between Sabel Industries, Inc. and: a) Keith Sabel, dated January 24, 1994 (2) b) Phillip Brown, dated January 24, 1994 (2) 10.20.1 -- Amendment to Net Worth Appreciation Agreements between Sabel Industries, Inc. and: a) Keith Sabel, dated January 15, 1999 (13) b) Phillip Brown, dated January 15, 1999 (13) 10.21 -- Waiver of "Additional Fees" through October 31, 1995 dated (3) January 11, 1996 between The Renco Group, Inc. and Renco Metals, Inc. 21.1 -- Subsidiaries of Renco Metals, Inc. (1) 27 -- Financial Data Schedule
- -------------------------------------------------------------------------------- (1) Previously filed and incorporated herein by reference from the Registrants' Registration Statement on Form S-4 (file no. 33-68230) as declared effective by the Securities and Exchange Commission on December 3, 1993. (2) Previously filed and incorporated herein by reference from Renco Metals, Inc.'s Form 10-K for the fiscal year ended October 31, 1994 (File No. 33-68230). -45- 46 (3) Previously filed and incorporated herein by reference from Renco Metals, Inc.'s Form 10-K for the fiscal year ended October 31, 1995 (File No. 33-68230). (4) Previously filed and incorporated herein by reference from Renco Metals, Inc.'s Form 10-Q for the quarterly period ended January 31, 1996 (File No. 33-68230). (5) Previously filed and incorporated herein by reference from the Registrants' Registration Statement on Form S-1 (File no. 333-4513) as declared effective by the Securities and Exchange Commission on June 27, 1996. (6) Previously filed and incorporated herein by reference from Renco Metals, Inc.'s Form 8-K, filed July 17, 1996 (File No. 333-4513). (7) Previously filed and incorporated herein by reference from Renco Metals, Inc.'s Form 10-Q for the quarterly period ended July 31, 1996 (Files No. 33-68230 and 333-4513). (8) Previously filed and incorporated herein by reference from Renco Metals, Inc.'s Form 10-K for the fiscal year ended October 31, 1996 (Files No. 33-68230 and 333-4513). (9) Previously filed and incorporated herein by reference from Renco Metals, Inc.'s Form 10-K for the fiscal year ended October 31, 1997 (File No. 333-4513).. (10)Previously filed and incorporated herein by reference from Renco Metals, Inc.'s Form 10-Q for the quarterly period ended July 31, 1998 (File No. 333-4513). (11)Previously filed and incorporated herein by reference from Renco Metals, Inc.'s Form 10-K for the fiscal year ended October 31, 1998 (File No. 333-4513). (12)Previously filed and incorporated herein by reference from Renco Metals, Inc.'s Form 10-Q for the quarterly period ended July 31, 1999 (File No. 333-4513). (13)Filed herewith electronically B. No reports on Form 8-K were issued subsequent to the Registrant's Quarterly Report on Form 10-Q for the quarter ended July 31, 1999. -46- 47 Schedule II RENCO METALS, INC. AND SUBSIDIARIES Valuation and Qualifying Accounts Years ended October 31, 1999, 1998, and 1997 (dollars in thousands)
Balance Additions at charged Deductions- beginning to costs write-offs Balance of and against at end year expenses allowance of year --------- -------- ---------- -------- Year ended October 31, 1999: Applied against asset accounts: Allowance for doubtful accounts $ 514 180 (162) 532 Allowance for inventory obsolescence 442 295 (176) 561 Year ended October 31, 1998: Applied against asset accounts: Allowance for doubtful accounts $ 514 37 (37) 514 Allowance for inventory obsolescence 442 - - 442 Year ended October 31, 1997: Applied against asset accounts: Allowance for doubtful accounts $ 514 163 (163) 514 Allowance for inventory obsolescence 442 - - 442
-47- 48 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. RENCO METALS, INC. (Registrant) Date: January 27, 2000 By /s/ Ira Leon Rennert - ------------------------------------- --------------------------------- Ira Leon Rennert Chairman of the Board and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Date: January 27, 2000 /s/ Ira Leon Rennert - ------------------------------------- --------------------------------- Ira Leon Rennert Chairman of the Board, sole Director, and Chief Executive Officer (Principal Executive Officer) Date: January 27, 2000 /s/ Roger L. Fay - ------------------------------------- --------------------------------- Roger L. Fay Vice President, Finance (Principal Financial and Accounting Officer) SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT No annual report to security holders covering the registrant's last fiscal year and no proxy statement, form of proxy or other proxy soliciting material with respect to any annual or other meeting of security holders has been nor will be sent to security holders. -48- EX-10.20.1 2 AMENDMENT TO NET WORTH APPRECIATION AGREEMENTS 1 EXHIBIT 10.20.1 (a) SABEL INDUSTRIES, INC. 749 NORTH COURT STREET MONTGOMERY, AL 36104 As of January 15, 1999 Mr. Keith Sabel Sabel Industries, Inc. 749 North Court Street Montgomery, AL 36104 RE: AMENDMENT TO NET WORTH APPRECIATION PARTICIPATION AGREEMENT Dear Mr. Sabel: This will confirm the understanding of this Corporation (the "Company") with you with respect to our agreed amendments to your Net Worth Appreciation Participation Agreement dated January 24, 1994 (the "Agreement"). As you know, our parent company, The Renco Group, Inc. ("Renco"), has elected to become, for Federal Internal Revenue Code purposes, a subchapter S corporation (instead of a subchapter C corporation), effective with its fiscal year beginning November 1, 1998, and has designated this Company and its subsidiaries as qualified subchapter S subsidiaries (the "S election"). This designation is also applicable for those states which recognize such election. This letter is intended to set forth our understanding as to the changes in the Agreement intended to accommodate such election. It is the intent of the parties to the Agreement that the S election not alter the benefits payable under the Agreement; therefore we agree as follows: A. For purposes of calculating the benefits payable under the Agreement, the Company will continue to calculate Federal corporate income taxes and the corporate income taxes for those jurisdictions in which the Company and its subsidiaries do business, for fiscal periods beginning on or after November 1, 1998, as if this Company and its subsidiaries had continued to have C corporation status, under the Federal Internal Revenue Code and under state and local tax laws, in accordance with the provisions of generally accepted accounting principles and the Internal Revenue Code and regulations thereunder and under state and local tax laws applicable to C corporations as from time to time in effect ("C Status"). Such tax calculations will include calculations of current and deferred tax expense or benefit and current and non-current tax assets and liabilities ("C Taxes") and the differences ("Tax Differences") between the C Taxes and the taxes as recorded by the Company and its subsidiaries while being designated a qualified subchapter S subsidiary ("S Taxes"). Cumulative Income Statement Tax Difference shall be the cumulative difference in income tax expense or benefit between the calculation of the C Taxes and S Taxes, in each case calculated for the tax periods beginning on or after November 1, 1998 and through the end of the calculation period. Cumulative Cash Flow Tax Difference shall be the cumulative difference in income tax payments, net of refunds, between the calculation of the C Taxes and S Taxes in each case made after November 1, 1998 or, which would be in the case of C Taxes, or are in the case of S Taxes, immediately due and payable contemporaneously with the payment of any dividends. 2 In connection with the annual audit of the financial statements of the Company, the Company's Board of Directors will require that the independent public accountants issue a special report indicating their agreement with the Tax Differences. B. Any payment due to you under Paragraph 2 of the Agreement (the "Termination Benefit") shall be (A) 5% of the cumulative net income, as defined, less (B) 5% of the Cumulative Income Statement Tax Difference (the calculation period shall end at the end of the Company's fiscal quarter immediately preceding your date of termination) and excluding such Cumulative Income Statement Tax Difference to the extent equal to Cumulative Cash Flow Tax Difference utilized in calculating an Additional Compensation Benefit under Paragraph 3. C. Any payment due to you under Paragraph 3 of the Agreement in regard to dividends paid by the Company (the "Additional Compensation Benefit"), shall be (A) the excess of 5% of the cumulative dividends paid by the Company subsequent to November 1, 1998 over 5% of any positive Cumulative Cash Flow Tax Difference less (B) the amount of Additional Compensation Benefit previously paid to you under Paragraph 3 subsequent to November 1, 1998. D. Any payment due to you under Paragraph 5 of the Agreement (the "Sale Proceeds Benefit"), shall be (A) 5% of any net proceeds, as defined, plus (B) 5% of the cumulative dividends paid by the Company subsequent to November 1, 1998, less (C) 5% of the Cumulative Income Statement Tax Difference through the date of sale, and less (D) the amount of any Additional Compensation Benefits previously paid to you under Paragraph 3 subsequent to November 1, 1998. E. As amended hereby, the Agreement shall continue in full force and effect. Please confirm that the foregoing correctly sets forth our understanding by signing and returning the enclosed duplicate of this letter. Very truly yours, SABEL INDUSTRIES, INC. /s/ Ira Leon Rennert ------------------------ Ira Leon Rennert Chairman of the Board Accepted and Agreed to: /s/ Keith Sabel - ------------------------ Keith Sabel 3 EXHIBIT 10.20.1 (b) SABEL INDUSTRIES, INC. 749 NORTH COURT STREET MONTGOMERY, AL 36104 As of January 15, 1999 Mr. Phillip Brown Sabel Industries, Inc. 749 North Court Street Montgomery, AL 36104 RE: AMENDMENT TO NET WORTH APPRECIATION PARTICIPATION AGREEMENT Dear Mr. Brown: This will confirm the understanding of this Corporation (the "Company") with you with respect to our agreed amendments to your Net Worth Appreciation Participation Agreement dated January 24, 1994 (the "Agreement"). As you know, our parent company, The Renco Group, Inc. ("Renco"), has elected to become, for Federal Internal Revenue Code purposes, a subchapter S corporation (instead of a subchapter C corporation), effective with its fiscal year beginning November 1, 1998, and has designated this Company and its subsidiaries as qualified subchapter S subsidiaries (the "S election"). This designation is also applicable for those states which recognize such election. This letter is intended to set forth our understanding as to the changes in the Agreement intended to accommodate such election. It is the intent of the parties to the Agreement that the S election not alter the benefits payable under the Agreement; therefore we agree as follows: A. For purposes of calculating the benefits payable under the Agreement, the Company will continue to calculate Federal corporate income taxes and the corporate income taxes for those jurisdictions in which the Company and its subsidiaries do business, for fiscal periods beginning on or after November 1, 1998, as if this Company and its subsidiaries had continued to have C corporation status, under the Federal Internal Revenue Code and under state and local tax laws, in accordance with the provisions of generally accepted accounting principles and the Internal Revenue Code and regulations thereunder and under state and local tax laws applicable to C corporations as from time to time in effect ("C Status"). Such tax calculations will include calculations of current and deferred tax expense or benefit and current and non-current tax assets and liabilities ("C Taxes") and the differences ("Tax Differences") between the C Taxes and the taxes as recorded by the Company and its subsidiaries while being designated a qualified subchapter S subsidiary ("S Taxes"). Cumulative Income Statement Tax Difference shall be the cumulative difference in income tax expense or benefit between the calculation of the C Taxes and S Taxes, in each case calculated for the tax periods beginning on or after November 1, 1998 and through the end of the calculation period. Cumulative Cash Flow Tax Difference shall be the cumulative difference in income tax payments, net of refunds, between the calculation of the C Taxes and S Taxes in each case made after November 1, 1998 or, which would be in the case of C Taxes, or are in the case of S Taxes, immediately due and payable contemporaneously with the payment of any dividends. 4 In connection with the annual audit of the financial statements of the Company, the Company's Board of Directors will require that the independent public accountants issue a special report indicating their agreement with the Tax Differences. B. Any payment due to you under Paragraph 2 of the Agreement (the "Termination Benefit") shall be (A) 2% of the cumulative net income, as defined, less (B) 2% of the Cumulative Income Statement Tax Difference (the calculation period shall end at the end of the Company's fiscal quarter immediately preceding your date of termination) and excluding such Cumulative Income Statement Tax Difference to the extent equal to Cumulative Cash Flow Tax Difference utilized in calculating an Additional Compensation Benefit under Paragraph 3. C. Any payment due to you under Paragraph 3 of the Agreement in regard to dividends paid by the Company (the "Additional Compensation Benefit"), shall be (A) the excess of 2% of the cumulative dividends paid by the Company subsequent to November 1, 1998 over 2% of any positive Cumulative Cash Flow Tax Difference less (B) the amount of Additional Compensation Benefit previously paid to you under Paragraph 3 subsequent to November 1, 1998. D. Any payment due to you under Paragraph 5 of the Agreement (the "Sale Proceeds Benefit"), shall be (A) 2% of any net proceeds, as defined, plus (B) 2% of the cumulative dividends paid by the Company subsequent to November 1, 1998, less (C) 2% of the Cumulative Income Statement Tax Difference through the date of sale, and less (D) the amount of any Additional Compensation Benefits previously paid to you under Paragraph 3 subsequent to November 1, 1998. E. As amended hereby, the Agreement shall continue in full force and effect. Please confirm that the foregoing correctly sets forth our understanding by signing and returning the enclosed duplicate of this letter. Very truly yours, SABEL INDUSTRIES, INC. /s/ Ira Leon Rennert ------------------------ Ira Leon Rennert Chairman of the Board Accepted and Agreed to: /s/ Phillip Brown - ------------------------ Phillip Brown EX-27 3 FINANCIAL DATA SCHEDULE
5 1,000 12-MOS OCT-31-1999 NOV-01-1998 OCT-31-1999 8,448 0 26,010 532 44,979 80,583 102,146 60,284 126,091 21,362 153,229 0 0 1 (60,194) 126,091 179,613 179,613 127,694 158,599 0 180 18,618 3,355 (1,963) 5,318 0 0 0 5,318 0 0
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